Sole Proprietorships
One of the easiest and most inexpensive b 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.
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 don’t 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. 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 don’t 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.
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. b 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 doesn’t 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.
Choosing to form a partnership only works if the partners as a whole
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 don’t 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 an 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. b 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 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 b the tax liability can’t 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. b All of 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.
