Chapter 10 - Sole Proprietorships, Partnerships, LLCs, and S Corporations
Questions and Problems for Discussion
A sole proprietorship is not a legal entity but merely a business activity carried on by an individual.
The proprietor is personally liable to the business creditors. The net profit or loss from the activity is
part of the proprietor’s taxable income. Because a sole proprietorship has no separate identity from
its proprietor, it can’t be described as a passthrough
Mrs. Liu should use the marginal rate applying to the next dollar of taxable income on Form 1040.
If the $17,000 business loss exceeds the total of Mr. Pitt’s other income items for the year (salary,
dividends, interest, etc.), the excess qualifies as a net operating loss, which he can carryback as a
deduction to his two prior taxable years.
Firm Q remitted $13,400 employer payroll tax (which it deducted as a business expense) and
$13,400 employee payroll tax withheld from the compensation paid to its employees during the year.
The employee payroll tax is extremely convenient because the responsibility for computing and
paying the tax is on the employer, not the employee. However, the payroll tax rate structure is
regressive: 7.65 percent on a base amount of annual compensation + 1.45 percent on compensation
in excess of the base. In 2007, the employee payroll tax on $50,000 compensation is $3,825 for an
average rate of 7.65 percent. The employee payroll tax on $200,000 compensation is $8,945 for an
average rate of 4.47 percent. Thus, the employee payroll tax is often criticized as vertically
The self-employment tax is based on net earnings from self-employment, which is essentially the
profit that sole proprietors earn from their business. Individuals pay their self-employment tax at the
same time and in the same manner as they pay income tax.
The income tax deduction for one-half of self-employment tax corresponds to the employer’s
payroll tax. The nondeductible one-half of self-employment tax corresponds
to the nondeductible
General partners have unlimited personal liability for all recourse debts of their partnership.
Limited partners have no personal liability for the debts of their partnership. However, Tom,
Angela, and Peter all cannot be limited partners because a limited partnership must have at
least one general partner.
The members of an LLC have no personal liability for the debts of their company.
The shareholders of an S corporation have no personal liability for the debts of their corporation.
Any item recognized by a passthrough entity that is subject to a special rule, limitation, or treatment
in the computation of individual or corporate taxable income or tax liability must be separately stated.
This separate accounting allows each owner to apply the special rule, limitation, or treatment to that