There are times when a new client will come to our firm, and they are trying to decide what type of
entity to choose for their new business venture. To figure out what type of entity we need to figure
out what exactly the business is and typically what type of liability the owners will have or need to
have protected. A sole proprietorship is a business that an individual reports typically on a schedule
C or F on their individual tax return. On advantage is there is no other federal tax return
requirement since the information is reported in the individuals return. Some disadvantages are that
there can only be one owner and there is no liability protection for that person. A sole proprietor
can take money out of the business at any time since only the income and expenses are reported on
their individual tax returns. A partnership can be defined as a general partnership, limited
partnership, or a limited liability company. An advantage to forming a general partnership is that
entity can have two or more members. [Another advantage is] a partnership is a tax reporting, but
not taxpaying, entity (Anderson, Hulse & Rupert 2023). Each partner gets a K-1 and the income is
reported on their tax returns. The positive side to getting a K-1 and reporting the income is that
these members can take money out of the partnership by taking tax free distributions. A
disadvantage is that there is no liability protection. The partners are all liable for any debts that the
partnership cannot pay.
A C corporation has the best advantage as the shareholders do not have any liability to the company
personally. A C Corporation also have the biggest disadvantage which is the shareholders cannot
take distributions without getting double taxation. The only way a shareholder can take money out
of a C corporation is to take wages or to take taxable dividends.
The taxable entity I chose for the new business owner is a partnership. The business is investing in
large real estate transactions to be converted as rentals (for example, large apartment complexes).
This is the safest choice for a few reasons. They can choose a partnership to have the partners
liability be limited, which is beneficial if they start purchasing multiple large pieces of real estate and
have a sum of mortgage loans over $10,000,000. Another reason they should choose a partnership
is that they can take large distributions in income producing years that are not included in income.
The last benefit is that when the partnership is starting up the partners can deduct the partnership
loss on the k-1 to the extent of the partners basis in the total debt on the balance sheet. For
example, if there is a $10,000,000 debt on the balance sheet on the liabilities section the partners
can deduct a loss up to $10,000,000. If that loss is not met on the first year, they can keep having a
loss until the total debt is used (which hopefully does not happen, or they will not have a profitable
partnership).
Sole Proprietorships
One of the easiest and most inexpensive business to own is a small business or sole proprietorship
that usually is usually owned by and operated by one person. Sole proprietorships have no
employees and the income is generally reported on the individuals personal tax return as pass
through income. There is no distinction between the business and the owner which can be a
disadvantage to owning a sole proprietorship but you are entitled to all profits which can be
advantage. This downside to this as sole proprietor the owner is also responsible for the sole
proprietorship’s liabilities, losses, and debts which can be a disadvantage.
Since sole proprietors usually use their social security number to report their income from self-
employment but this makes it difficult to obtain funding for the business and build credit. This is a
disadvantage because the sole proprietor’s personal credit is not separated from the business credit
making it harder to determine credit worthiness of the actual business. This results in the sole
proprietor not being protected from any commercial debt, lawsuit, or obligations held under the
business another big disadvantage because the sole proprietor assumes the personal risk of
operating the business. c c c
Owning a sole proprietorship can have its advantages since they are quick, easy, and inexpensive to
form. There is no annual paperwork or state filings, which saves money and keeps startup costs low.
Since the income flows through the individuals personal tax return the owner is only responsible for
personal taxes on the federal, state, and local (as necessary) and apart from FICA and self-
employment taxes owners do not pay any business taxes or unemployment taxes.
Choosing to form a sole proprietorship is good for first time business owners who must grow their
business.
Longo, R. (2020, November 23). LLC or sole prop? which one is best for your business? Duquesne
Univ. SBDC. Retrieved February 1, 2023, from htps://www.sbdc.duq.edu/Blog-Item-Limited-LLC-vs-
Sole-Proprietorshipt
Partnerships
A more complex business a new business owners can form is a partnership. Partnerships are formed
by two or more people to offer a service or trade. c Entering a partnership can offer several
advantages since each person contributes to the operation of the business. Partners usually
contributes a portion of their own money, property, or skill to contribute to the successful operation
of the business and partners share both profits and losses during the operation of the business
partnership.
Income from partnerships is reported as an entity and partners are required to file annual
information returns to repot the income or loss from the operation of the business as well any
eligible business deductions, gain, or loss incurred during the operation of the business.
Partnerships do not pay any income taxes but the partners must report their share of the
partnership’s income or losses on their personal tax return.
Entering a partnership has its advantages by providing access to knowledge and best business
practices to mitigate risk and reduce potential mistakes in the operation of the business. Running a
partnership also increases efficiency as the costs of running the business are reduced between
partners but startup costs can still be costly. Partnerships also allow businesses to achieve long term
stability by creating more appropriate products and services through innovation and collaborative
efforts. c
Partnerships do have their advantages but harder to form since they are expensive and more
challenging to form forming a disadvantage. The high cost to start partnerships are only the
beginning to the disadvantages in forming a partnership. c c If a conflict of interest arises this could
create a negative impact if the decision may be good for the business but unsettling to some
individuals involved if the decision does not align with the individuals’ interests. This can create
conflict within the partnership if a common ground is not found which can make having a
partnership detrimental. Partnerships can also drain resources a partner fails to meet contribution
of time, money, skills, or efforts which could lead to full dissolution if another’ partners resources
are depleted. c
Choosing to form a partnership only works if the partners will benefit from the contributions of each
partner. When this happens, the partnership will begin to see tangible added value to partnership
that will allow for growth of the partnership. Individuals should keep in mind the when forming a
partnership, the common and shared goals of the individuals’ partner. If the individual partners
goals do not align long term stability is harder to achieve.
SDG Partnership Accelerator. (n.d.). Training and services. The Benefits and Risks of Partnering.
Retrieved February 1, 2023, from https://thepartneringinitiative.org/the-benefits-and-risks-of-
partnering/
irs.gov. (2022, November 2). Partnerships: Internal Revenue Service. Partnerships | Internal Revenue
Service. Retrieved February 1, 2023, from https://www.irs.gov/businesses/partnerships
Corporations
Corporations are some of the most advanced businesses a new business owner can form and the
most expensive as usually corporations are formed are legal entities separate from their owners.
The owners of the corporation are known as shareholders that bear no personal liability to the debt
of the corporation, only the amount invested into the corporation which is seen as one of its
greatest advantages. Corporations are usually large companies that offer a variety of goods and
services, significant employment, and stimulate economic growth. These are also some of the
primary advantages of starting a corporation but transitioning into a corporation from a small
business is usually seen as a long-term goal of owning a small business.
Corporations are usually one of the most expensive forms of business a new business owner can
form. The startup costs are usually very high and business owners who wish to incorporate must
apply at the state level and be approved to incorporate in the state they are applying to. c This can
become challenging as many state laws vary on the incorporation of a business which can be a
major disadvantage if the business owner is unfamiliar with the state laws where they do business.
Another major disadvantage to incorporating a business is after the incorporation the business can
only engage in the activities for which the business was established making it difficult to expand if
the corporation wants to expand into activity for which it not approved for established to do
business for.
It may be best to consider forming a corporation at the need of the business as it may not be
beneficial for tax purposes. The tax rate for corporations is usually higher and corporations are taxed
twice when reporting taxes. Corporations are taxed on a corporate level and taxed again once
dividends are issued to shareholders which can be a disadvantage when running a corporation if the
tax liability cannot be met.
WAHLEN, J. A. M. E. S. M., Jones, J. P., & Pagach, D. (2023). Chapter 15 Contributed Capital: How Are
Corporations Organized? In Intermediate accounting: Reporting and analysis (pp. 15–2-15–4). book,
CENGAGE LEARNING.
Example
As an accountant if a client approached me wanting to open freelance photography business, I
would recommend that my client open a Sole proprietorship. The startup costs will be low and they
will enjoy all the advantages of having a Sole proprietorship with very little exposure to the
disadvantages. Starting the business as a sole proprietorship will allow the business the room it will
to grow into a limited liability company, partnership, or even corporation. c All the profits made in
the business will go directly to the client and they will only be responsible for paying taxes on the
profits without worrying about paying additional taxes for the business which can lead to undue
burden if tax obligations are not met.
Anderson, Kenneth E., Hulse, David S., Rupert, Timothy J. (2023). Pearson’s Federal Taxation 2023
Corporations, Partnerships, Estates and Trusts. Pearson Education Inc. Hoboken, NJ.
