Module one overview: Federal income tax is a significant business expense that has a large impact on the decisions made by entrepreneurs when contemplating starting up a new business. One of the decisions that must be made early in the process of starting a business is to select the taxable entity that will be used to report the results of operations to the Internal Revenue Service (IRS). Business owners need to understand the advantages and disadvantages of operating as a sole proprietor, a partnership, or a corporation.Sole ProprietorshipsSole proprietorships are the most common forms of business in the Unites States because they are easy and inexpensive to start up. In most cases, a business license fee of a minimal amount is all that a sole proprietor needs to open the business. The owner has complete control over a sole proprietorship, and it is easy to sell or close if the owner decides to move on to another venture. Some of the disadvantages of sole proprietorships include paying taxes on the income of the business regardless of whether the owner took withdrawals for personal use, and the tax rate maybe higher than the corporate tax rate on the earnings that are paid to shareholders as dividends (Joyner, 2015).PartnershipsWhen two or more individuals decide to start a new business, the individuals might consider operating as a partnership. Similar to sole proprietorships, partnerships are easy to start up. A partnership can be formed based on an oral agreement, but most accountants and lawyers insist that a written agreement be prepared. Partnerships prepare an information return that lets the IRSknow how much taxable income each partner will report on his or her personal tax returns. The tax rate on the earnings could be higher than the rate paid by shareholders of corporations. The partners pay tax on their share of earnings regardless of whether the partners have withdrawn anyfunds for their personal use. The income from partnerships, along with certain deductions and other separately stated tax items flow through the partnership to the partners’ personal tax returns. Partners are not employees of a partnership, and that means the partners will not have thetax advantage of having non-taxable employee benefits such as life insurance and health insurance that can be provided to employees without increasing their taxable income for the benefits. In addition, partnership income allocated to partners is subject to self-employment taxes, which means the partners must pay the Social Security and Medicare taxes on their incomefrom the partnership.Limited Liability Company ElectionSole proprietorships and partnerships provide virtually no liability protection for owners. An owner may lose personal assets along with business assets if an accident occurs and a lawsuit is filed. Entrepreneurs should consider filing the paperwork to create a limited liability company to protect assets if the business is a sole proprietorship or a partnership for tax reporting purposes.Types of Corporations
A new business can be incorporated. When considering incorporation, business owners may
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- Winter '15
- Taxation in the United States