Each type of business entity has pros and cons as well as tax consequences. This article offers some basics about two of the most popular business formats: sole proprietorships and partnerships.
Businesses often start out as sole proprietorships simply because it is easier at the beginning. Unlike other business structures, no formal set up is involved. Sole proprietorships are viewed as pass-through entities because all business income and losses are reported on the business owner’s personal tax return rather than on a separate business return. Profits and losses are reported on Schedule C, which is submitted with Form 1040. Following are specific rules that affect the taxation of sole proprietorships:
Once the business reaches a certain level of profitability, the business owner may choose to restructure the business. Doing so allows the owner to protect his or her personal assets. Usually, it also results in lower taxes.
Forms of Partnerships
A business owner’s options also include partnerships. Partnerships are similar to sole proprietorships in that both business structures are pass-through entities. Partnerships report their income and expenses on a partnership tax return, and each partner reports his or her share of the profits or losses on their personal return. Partners may be general partners — that is, partners whose liability for the business is not limited — or limited partners. The liability of limited partners toward the business’s debts is legally limited to the extent of his or her investment.
There are three common types of partnerships:
Sometimes, businesses opt to maintain their sole proprietor or partnership structure throughout the business’s life cycle. Other times, the business chooses to restructure to a corporate business model. Call us today to determine whether it is time for your business to restructure.
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