A Sole Proprietorship is an Unincorporated Business

A sole proprietorship is an unincorporated business owned by one individual (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019). From a tax perspective, a sole proprietorship is not a separate entity, but rather an extension of the owner. The income and loss are reported on the individual tax return of the business owner. Some of the tax advantages associated with a sole proprietorship are that income earned by the business is taxed at the owner’s marginal rate, profits may qualify for the 20% qualified business income deduction, the owner can contribute cash or withdraw profits without tax consequences, and that despite the business having separate books and accounts, the money belongs to the owner personally (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019). Some of the disadvantages are that the profits are taxed to the owner regardless of if the ports are retained in the business or withdrawn for personal use, corporate tax rate can be lower than individual tax rates, and a sole proprietor must pay the full amount of social security taxes because he or she is not considered an employee of the business (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019).
A partnership is an unincorporated business carried on by two or more individuals or entities for profit (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019). This is a tax reporting, but not taxpaying entity. Income, expenses, losses, credits, and other tax-related items are passed to the partners whose report these items on their separate tax returns. Similar to a sole proprietorship, each partners share of business profits are added to other income and taxed at the partner’s marginal rate. Some of the tax advantages of a partnership are the partnership as an entity pays no tax (taxed at partner level only), pass-through income may qualify for the 20% qualified business income deduction, and subject to limitations, partners can use losses to offset income from other sources (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019). Some of the tax disadvantages are the partnerships profits are taxed to the partners when earned (not always distributed), a partner’s tax rate could be higher than corporation tax rate, and a partner must pay the full amount of self-employment taxes on their share of the partnership (not considered employees) (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019).
Corporations are separates entities that provide shareholders with limited liability. There are two types of corporations, C and S. C corporations are subject to double taxation, meaning that tax is paid at the corporate level and again at the shareholder level after earnings are distributed as dividends. S corporations are similar to a partnership in that earnings are accounted for at the corporate level but taxed only at shareholder level.
Some advantages of a C corporation are that aggregate tax savings may result when earnings are not distributed, and compensation and certain benefits paid to shareholder-employees can be deducted (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019). Some c corporation disadvantages are the occurrence of double taxation when earnings are distributed as dividends, shareholders can’t withdraw money from the corporation without recognizing income, and net operating losses offer no tax benefit to the owners in the year they are incurred (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019).
Some of the advantages of S corporations are they pay no tax at the corporate level but rather at the shareholder level, pass-through income may qualify for 20% qualified business income deduction, and corporate losses flow through individual returns of shareholders and can be used to offset earned income from other sources (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019). Some of the disadvantages are that shareholders are taxed on profits regardless distribution status, individual marginal tax rates could exceed that of a C corporation, and nontaxable fringe benefits are not available to employees (Anderson, K. E., Rupert, T. J., & Pope, T. R., 2019).
One example of a business that would benefit from identifying as a sole proprietorship is a lawyer looking to practice law under their own name. By acting as a sole proprietor, this lawyer would be able to conduct business under their own name without having to create a separate entity since a sole proprietorship acts as a legal extension of the business owner. The lawyer would not have to file any additional tax returns as the business income and expenses would be reported on Schedule C of the lawyer’s individual tax return. As a sole proprietor, the lawyer may qualify for the 20% qualified business income deduction while also having the option to contribute cash to, or withdraw profits from, the business without tax consequences.