There are multiple advantages and disadvantages to choosing a Sole Proprietorship, Partnership
or Corporation. Sole Proprietorships are a legal extension of the owner, with income and
expenses reported on Schedule C of Form 1040. The individual tax rate may be lower than a
corporation. An owner of a Sole Proprietorship can contribute or withdraw money without tax
consequences, and the money belongs to the owner personally. Disadvantages include income
being subject to Self-Employment taxes at a rate of 15.3%. The fiscal year of the Sole
Proprietorship must be the same as the owner/individual, which means income cannot be
deferred. Salaries paid to the owner are not deductible.
Partnerships are an unincorporated business with two or more owners. Income and expenses
are reported on Form 1065, but the entity does not pay taxes. Income and all tax related items
flow to the partners on Form K-1, which must be included with their individual tax return. The
Partnership can be either General or Limited. General Partnerships liability is unlimited for
each partner and can be greater than their investment. Limited Liability partners are only liable
to the extent of their investment. Profits are taxed at the partner level, regardless of if there
are distributions or not during the year. Self-Employment tax of 15.3% is the be paid on
income.
Corporations can be formed as either an S Corporation or C Corporation. Both have limited
liability. C Corporations report income and expenses on Form 1120. Shareholders of the C Corp
are taxed on dividends reported on Form K-1. The individual tax rate may be higher than the
tax rate of a C Corp. Shareholders are entitled to fringe benefits, half of Social Security and
Medicare withholding are paid by the Corporation and salaries can be deducted. A
disadvantage of C Corporations is double taxation. Profits are taxed at a corporate level, and
distributions are taxed at the shareholder level. S Corporations have limits to the number of
shareholders but are not subject to double taxation. All earnings flow to the shareholders on
form K-1 based on their ownership percentages and are reported on their individual tax return.
Example:
Charlene decides to help a few friends by doing their bookkeeping on a quarterly basis. She
does not plan on this becoming a large business and does not have many expenses. She would
benefit from running this business as a Sole Proprietorship, as it will not be her sole source of
income, and she does not expect a large revenue stream. This can easily be recorded on Form
Schedule C to keep things simple.
