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There are many advantages for each type of business. Sole Props are the easiest to set up since the
paperwork is minimal. A partnership is a a business set up by two or more people. A LLC (limited
Liability Corporation) is a flexible business that combines the aspects of both partnerships and
corporations. Corporations are created by shareholders. They have many more tax advantages then the
other types.
Sole Props allow the owner to have complete control. However, it also provides the least protection
from personal assets. z Partnerships have pass through entity which means that the income is treated as
the owners’ incomes so it is only taxed once. Owners in partnerships are responsible for the liabilities
of the firm. (Team, 2022) there are different aspects of partnerships: General, Limited Partnership, and
LLPs. LLCs are the best of both worlds. LLCs protect the owners from any personal liabilities. The
Corporations can be classified as C Corp and S Corp. C Corps are double taxed: once at the entity
level and then again individually. S Corp are a pass through so they are only taxed once.
As far as disadvantages and advantages of sole proprietorship, corporations, and partnerships are
Sole Proprietorships - The advantages of sole proprietorships are the owners have an elevated level of
autonomy to run their business. Next, there are truly little Federal, State, and Local regulations for sole
proprietorships. Also, sole proprietorships do not have to pay the corporate tax rate and deal with
double taxation. Some disadvantages are the lack of liability for the owner. Meaning they are
responsible for personal and business debt obligations comprehensively. In other words, they are
personally responsible for all business debts. Partnerships- In a partnership one big advantage is the
share of responsibility of the partners to manage and run the business. Also, Partners report their share
of profits and losses on their personal income tax returns. They also do not have to file a business tax
return. Disadvantages are the liabilities are comprehensive for partners being serious and personal
debt.
Corporations- Some advantages to name are the limited liability protection for shareholders, directors,
and officers for company obligations. That said, a shareholder's debt liability does not exceed his
investment. Corporations can also raise capital by issuing stocks and bonds but not paying the
corporations' existing obligations before issuing. On disadvantages of course the big one, double
taxation. Meaning, Corporation must file a business tax return with the IRS and pay taxes on the
profits and losses at the corporation's applicable corporate tax rate. Shareholders are responsible for
their portion of dividends on their individual income taxes.
When determining in which way you should organize a business, one should consider the different
advantages and disadvantages and align them with the businesses' taxable and non-tax objectives.
There are multiple ways to form a business including sole proprietorships, partnerships, and
corporations.
Sole proprietorships are owned by an individual and earned income is taxed at the owner's marginal
rate. A 20% qualified business income deduction may be applied to profits. A corporation tax rate
may be higher than the proprietor's marginal tax rate thus providing a tax advantage. Since aligned
with the proprietor, money belongs to the owner and they may withdraw and deposit money without a
taxable consequence. Also, the owner may contribute or withdraw property without having to record a
gain or loss. If the business records a loss the owner can use it to offset non business income.
Disadvantages include not being able to retain earnings which is a limitation on tax planning as
income and losses cannot be differed. You can't determine your fiscal year but must adhere to the
calendar year, which also could limit tax planning. Owners are not treated as employees which
disqualifies them from non-taxable advantages such as group life insurance and non-deductible
compensation as well as having to pay individual and employee portions of Social Security and
Medicare taxes. z If the proprietor's marginal tax rate is higher than the corporate tax rate it creates tax
disadvantage. Partnerships share a lot of the same advantages and disadvantages as sole
proprietorships but are used by multiple owners with limitations on offsetting losses and exceptions on
gains and losses of property.
Unlike sole proprietorship and partnerships, C Corporations are subject to double taxation but reduce
the shareholders liabilities. They are taxed upon distribution of income through dividends and when
shareholder sell stock. While sole proprietorships and partnerships can lose busine and personal assets
C Corporations limit the shareholders' personal liability. They treat shareholders as employees which
are entitled to the benefits above that sole proprietorships and partnerships are excluded from. They
can determine their own fiscal year and retained earnings. Shareholders don't benefit from C
Corporations losses in the current year, but losses can carry back and forwards offsetting in other
years. Shareholders also have different benefits determined on how long they hold the stock.
S Corporations are treated like a partnership. They are taxed once as the corporate income is passed to
the shareholders and taxed to the shareholders. Like a partnership, they may qualify for a 20%
deduction, there is an advantage or disadvantage depended on if the shareholder's marginal tax rate is
higher or lower than the corporate tax rate. Shareholders do not have to recognizes gains and losses
upon contributing or withdrawing money. S Corporations are not subject to self-employment tax.
Gains are taxed as if the shareholder directly realized them at their capital gains rate, but this can offset
other sources of capital losses. Generally, S Corporations can't defer income like C Corporations
unless there is a business purpose that is legitimate.
There are different scenarios as to use the different business formations. One must consider the
advantages and disadvantages that apply to each and how they benefit the business being formed. z For
example, Gary is retired with a low marginal tax rate and is looking to start a business based on his
hobby of restoring cast iron skillets and selling them. z Since it is a hobby, he is simply looking to take
advantage of a business formation that would reduce his taxes given that he typically has a large
inventory with a low turnover rate. A tax advisor might suggest a sole proprietorship given that Gary
more likely than not will lose money if not break even thus allowing him to reduce his taxes. This
should allow Gary to take advantage of his hobby and offset his traditional 401k withdraws.
The form of business that is established can give rise to tax-related implications. When selecting a sole
proprietorship as the tax reporting entity for a new business, the main advantage is simple tax rules, as
the business income is reported on the proprietors personal income tax return (Cooper, 2016). A
major disadvantage is the personal liability of the owner. In a sole proprietorship business, the owner
takes the profit as his income, on which he has to pay tax just as on his main income.
The main advantage of selecting a partnership as a tax reporting entity is the easy set-up process and
simple taxation on the business income, which is considered as the personal income of the partners.
However, the main disadvantage is the personal liability of the partners in case of debts or financial
obligations (Tunnell, 2020). The payment of profits to owners is distributed as the personal income of
the partners. The tax is reported on the income tax returns of each of the partners of the partnership
business.
When a corporation form of business is chosen for a tax reporting entity, the chief advantage is that it
has a distinct legal identity which restricts the personal liability of the owners. The main disadvantage
is a complex taxation process due to the application of the double taxation method, where the
corporate has to pay tax on the income, and the shareholders must pay tax on dividends (Larisa, 2020).
This taxable entity accounts for payments to owners in the form of salaries, remuneration, wages and
dividends and they are considered the personal income of the owners on which tax is computed.
While opening a chain of gas stations along with three other investors, the type of business entity that
would be best to handle the tax reporting for the business is ‘partnership. The partnership has been
chosen as the ideal business type since it can be easily formed due to minimal compliance and
formality requirements. Each of the partners would have control over the decision-making process and
take vital decisions promptly (Efremova, 2020). In a partnership business, the taxation method is
simple since the business income would be the personal income of each of the partners based on the
predetermined ratio. The possibility of double taxation could be avoided, which would otherwise arise
in the case of a corporate form of business. The tax on the income would be charged as the normal tax
returns that are paid by the partners for their other or normal income.
There are 3 individuals forming a property company with rental income and interest income on
mortgages on properties they finance. In this case a partnership is ideal for the 3 individuals
considering they would have less liability as it is divided up among all 3 partners. Also, the managing
responsibilities are issued out and provide each with more flexibility and opportunities for their
business. They also would not be required to file a business tax return and each partner would be
individually responsible for his or her share of the losses and profits. Being able to avoid double
taxation and corporate tax rates.
References
Aleksandrovna Efremova, T. (2020). Developing tax administration in the context of the partnership
of participants of Tax Relations. 3C Empresa. Investigación y Pensamiento Crítico, 9(3), 109–123.
https://doi.org/10.17993/3cemp.2020.090343.109-123
Cooper, M., McClelland, J., Pearce, J., Prisinzano, R., Sullivan, J., Yagan, D., Zidar, O., & Zwick, E.
(2016). Business in the United States: Who owns it, and how much tax do they pay? Tax Policy and
the Economy, 30(1), 91–128. https://doi.org/10.1086/685594
Larisa, A. A., Fatima, S. A., & Madina, T. A. (2020). Double taxation: Concept, causes and procedure
for elimination. European Proceedings of Social and Behavioural Sciences.
https://doi.org/10.15405/epsbs.2020.10.05.170
Tunnell, L., & Ricketts, R. (2020). Taxation essentials of llcs and partnerships.
https://doi.org/10.1002/9781119722304
Anderson, Kenneth, et al., editors. Pearson’s Federal Taxation 2023 Corporations, Partnerships,
Estates & Trusts. Pearson Education, Inc, 2023.
Team, C. (2022, Nov 26). Types of Businesses. Retrieved from Corporate Financial Institute:
https://corporatefinanceinstitute.com/resources/management/types-of-businesses/
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