I have lived in Wisconsin (Go Packers!) my entire life and my background is in Tribal Gaming, or you
could say Government Accounting, for the past 25+ years. c I am married (25 exciting years and
counting) with one daughter of college age and two ankle biting Pomeranians. c I am not over the
moon excited about a tax course but I hope to change my perspective as I learn more about tax
planning over the next 10 weeks.
It can be very overwhelming when deciding on the right classification for a business venture. c
However, having the right team in your corner, explaining the 26 US Code options can make it a very
smooth process.
Sole proprietorship classification has the simplicity of including the business income and expenses
with the personal tax filing. c 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. c Meaning all the
business and personal assets are at risk. c 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. c Each
person contributes money, property, labour or skill, and experts to share in the profits and losses of
the business. c “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”. c The noticeable
advantage is that this classification eliminates any personal liability of the shareholders. c Then there
is the double taxation that occurs; corporation profits are taxed and then as shareholders receive
their dividend payout they are taxed again. c I am also worth mentioning that tax rates for
corporations are below what an individual business owner would apply to personal tax filings. c There
are several types of corporation classifications but the two main types are C Corp and S Corp. c 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)”. c 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. c But there would be a lot of personal liability to the partners if the venture were to
be unsuccessful. c Upon further research I would recommend the investors establish an S Corp
classification. c With a declared S Corp, the investor could/would make up the board of directors in
order to diplomatically make decisions for the business. c 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.
When starting a business, one of the first things that people need to worry about is the formation.
Anderson et al. (2023) explains the differences between the most popular ways to form a business.
A sole proprietorship is essentially the easiest business to start because it only involves one owner
and it has simple rules. This business entity is not subject to double taxation, and the owner will pay
their marginal rate on income after potentially qualifying for a 20% business deduction. On top of
these advantages, it is easy to contribute and withdraw cash and property. On the flip side, the full
tax amount must be paid on earnings whether they come out of the business or not. On top of that,
owner-employees are unable to deduct compensation and there are limitations on social security
tax cuts and using the fiscal calendar. Moving on, partnerships have a similar tax treatment as sole
proprietorships, there can just be multiple owners. Double taxation is avoided, and partners simply
pay taxes on their shares of earnings based on their individual rate, less a potential 20% business
income deduction. The disadvantages also closely mirror the last option, and partners are not
considered employees of the business, so there is not a lot of preferentially tax treatment for work
done within the business by owners. Finally, corporations offer a quite different approach because
they are an entity separate from their owners. The big difference is that in this case, there are more
deductions available and owner-employees can be considered separate employees. That results in
preferential tax treatment and benefits. On the negative end, double taxation typically results in a
higher tax bill. Furthermore, money withdrawn or deposited must be recognized and many losses
can’t be transferred to owners until they are realized.
Many times, the simpler solution is often the easiest. As an example, imagine four investors that
want to open a gas station together. If I was guiding their decision, I would advise them to set the
business up as a partnership formation within an llc. According to the IRS (2022), an LLC set up as a
partnership can avoid a lot of the upfront paperwork that you would get when forming a
corporation. Despite this, it offers limited liability and avoids double taxation. There is also a ton of
freedom when it comes to depositing and withdrawing within the business, and should things not
work out, it can easily be dissolved. Unfortunately, there could be some hang ups if the investors
want to spend a significant amount of time working in the business as employees. If that is the case,
a corporation may be favourable due to the separation.
Anderson, K., Hulse, D., and Rupert, T., Prentice Hall’s Federal Taxation 2023 Corporations,
Partnerships, Estates & Trusts. 2023.
IRS. (2022). Publication 541 (02/2022), Partnerships. Retrieved from
https://www.irs.gov/publications/p541#en_US_201312_publink1000104201
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
