This is an excerpt from a presentation I give to college students and to prospective entrepreneurs about types of business entities.
A college professor (who’s also an attorney) told me that my presentation on this subject is the best, clearest and most-concise overview of the topic that she’s ever seen.
I’m flattered by the compliment, and will try to translate those positives into a series of blog posts.
Now that we’ve laid out some basic terms, let’s get into the five types of business entities, starting with sole proprietorships.
Tax Notes About Sole Proprietorships
- Income and expenses of the proprietorship are reported on the proprietor’s personal income tax return, using an attachment called Schedule C.
- Proprietors pay both income tax and self-employment tax on the proprietorship’s net income. If the proprietorship suffered a loss, the proprietor gets to deduct that loss against other income on their personal tax return.
Advantages of Sole Proprietorships
- You’re the boss. By definition, sole proprietorships are owned by one person — the proprietor.
- Easy to get into. From a tax perspective, you start a proprietorship by starting to conduct business. You don’t have to file any special paperwork with the IRS to tell them you’re operating (unless you have employees). At tax time, you’ll file your Schedule C as part of your income tax return.
- Easy to get out of. If things don’t work out, you simply stop conducting business.
- Simple to administer. Generally, your accounting and legal fees will be lower with a proprietorship than with any other entity type.
- Easy to convert to something else. If a proprietor decides to incorporate, the process is easy. In our discussion of business entities, remember that it’s easy to go up the ladder (such as from a proprietorship to a corporation) but it’s hard to go down the ladder (such as from a corporation to a proprietorship).
Disadvantages of Sole Proprietorships
- Self-employment tax. For people who are new to self-employment, this additional 15.3% tax catches them off-guard.
- No salary deduction available. A proprietor can take as much or as little money out of the proprietorship as they wish — but those withdrawals are not “salaries” and are not deductible. (I covered this topic in much more detail in this blog post.)
- Income tax and self-employment tax is owed even if the proprietor takes no money out for themselves. (Again, see the blog post I linked to in #2 above.)
- Harder to raise capital. Banks may be less likely to take a sole proprietorship seriously. Also, it’s impossible to bring other people on board as investors, because as soon as you do that, you have a partnership rather than a sole proprietorship.