There are multiple advantages and disadvantages to choosing a Sole Proprietorship, Partnership or
Corporation. c 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. c 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. c 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. c
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.
Regardless of the entity structure, there are advantages and disadvantages to selecting a sole
proprietorship, a partnership, or a corporation for a new business. c Several considerations (including
tax reporting) must be considered. c A sole proprietorship is the easiest and most cost-effective to set
up (Ancheta, 2023). c This type of entity accounts for payments to owners who work at the business
by taking draws or drawing money out of the company. c Income and expenses are reported on the
personal tax return via a schedule C.
There are several different types of partnerships, but speaking in general terms a partnership is easy
to set up and is usually inexpensive to get started. c A partnership has an operating agreement
between the partners. It can elect to be taxed as a partnership or as a corporation. c A lot of the
partnerships that I work with have submitted the IRS form 2553 to elect to be taxed as an s-
corporation. c c Partners in a regular partnership typically receive guaranteed payments for services or
use of capital. However, if they have done the s-election they get paid payroll if they are working for
the business. c A partnership would file a 1065 tax return and income and expenses would pass
through to the partners on their personal return via a K-1. c If the 2553 was filed, they would
complete an 1120-S tax return. c Income and expenses would pass through to the personal tax return
via a K-1.
Again, there are several types of corporations. c A corporation is usually harder to set up. c They can
be subject to double taxation. c “C Corporations pay corporate taxes on earnings before distributing
their profits to the shareholders in the form of dividends. Individual shareholders are then subject to
personal income taxes on the dividends they receive” (Ancheta, 2023). c The income tax would be
calculated and due on the 1120 tax return. c No income and expenses are passed through to the
owner. c If an s-corporation was set up by filing the IRS form 2553, owners working at the business
would be paid payroll. c Income and expenses are passed through to the owners via a K-1 and
allocated by ownership interests. c An S-Corporation is required to have fewer than 100 shareholders.
Distributions are also sometimes given if warranted. c
When working in the accounting field, it is sometimes necessary to assist a new business owner with
identifying the most appropriate entity structure for tax purposes. c “A sole proprietorship is an
unincorporated business with one owner” (Rittenberg, 2023). c An example of a good fit for a sole
proprietorship would be a single owner starting out a very small photography business in their spare
time. c Income and expenses for the business would be reported on a Schedule C with the personal
tax return. c “As a sole proprietor, you are personally responsible for all your business debts and
obligations, including loans, leases, credit accounts and lawsuits.” (Rittenberg, 2023). c The nice thing
about a sole proprietorship is that it can always be converted to another type of entity in the future
should liability protection, for example, be a concern.
References:
Ancheta, A. (2023, January 23). What is a C corp? Investopedia. Retrieved February 2, 2023, from
https://www.investopedia.com/terms/c/c-corporation.asp
Rittenberg, J. (2023, January 24). What is a sole proprietorship? Forbes. Retrieved February 2, 2023,
from https://www.forbes.com/advisor/business/what-is-a-sole-
proprietorship/#:~:text=A%20sole%20proprietorship%20is%20an%20unincorporated%20business%2
0with,sole%20proprietorship%E2%80%93you%E2%80%99ll%20automatically%20be%20a%20general
%20partnership%20instead.
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.
