Sole proprietorship classification has the simplicity of including the business income and
expenses with the personal tax filing. While the tax reporting has simplicity, this option also
comes with the biggest disadvantage potential; that is the personal liability is all on the owner. a
Meaning all the business and personal assets are at risk. In summary, the classification of a sole
proprietorship, the owner is allowed all the profit and have unlimited liability responsibility for
debts against the business.
Partnership classification exists between two or more persons who join in a business venture.
Each person contributes money, property, labor or skill, and experts to share in the profits and
losses of the business. “A partnership must file an annual information return to report the
income, deductions, gains, losses, etc., from its operations, but it does not pay income tax.
Instead, it "passes through" profits or losses to its partners. Each partner reports their share of the
partnership's income or loss on their personal tax return (IRS, 2022).”
Corporation classification has shareholders vs. the traditional title “owners”. a The noticeable
advantage is that this classification eliminates any personal liability of the shareholders. Then
there is the double taxation that occurs; corporation profits are taxed and then as shareholders
receive their dividend payout they are taxed again. I is also worth mentioning that tax rates for
corporations are below what an individual business owner would apply to personal tax filings.
There are several types of corporation classifications but the two main types are C Corp and S
Corp. A C Corp classification is most often seen associated with larger businesses with more
than 100 shareholders; while an S Corp classification is designed for smaller less than 100
shareholder businesses and “elect to pass corporate income, losses, deductions, and credits
through to their shareholders for federal tax purposes (IRS 2023)”. Both classifications
distribute to shareholders using dividend payouts.
When approached by a small group of investors all wanting to band together to establish a Cheer
Gym for youth athletes; the best type of classification for this business venture at first glance
might be partnership. But there would be a lot of personal liability to the partners if the venture
were to be unsuccessful. Upon further research I would recommend the investors establish an S
Corp classification. With a declared S Corp the investor could/would make up the board of
directors in order to diplomatically make decisions for the business. This is also a good choice
because the shareholders each receive a Schedule K-1 reflects the S corporation's items of
income, loss and deduction that are allocated to the shareholder for the year, and in turn each
shareholder reports this information with personal tax filings.
References
Anderson, Kenneth, et al., editors. Pearson’s Federal Taxation 2023 Corporations, Partnerships,
Estates & Trusts. Pearson Education, Inc, 2023.
26 US Code (1986) U.S. Code: Title 26 Retrieved from: www.law.cornell.edu
IRS (Sept 2022) Sole Proprietorships Retrieved from: www.irs.gov
IRS (Nov 2022) Tax Information for Partnerships Retrieved from: www.irs.gov
IRS (Jan 2023) Forming a Corporation Retrieved from: www.irs.gov
