A Taxing Consideration: Choosing a Business Structure (Sole Proprietorship)

When people are starting a business, they are often very confused and overwhelmed as to how to choose an entity, or even whether they need one. Many entrepreneurs understand corporations or LLCs can limit legal liability, but they don’t know there can be very different tax implications. The only entities which provide limited liability to owners (with respect to both tort and contract liability) are S corporations, C corporations, and limited liability companies. Before selecting the entity, it is essential to review the tax implications, as well as the legal ones.

In a series of blog posts, I will discuss the various available entities (sole proprietorship, partnership, limited liability company, C-corporation and S-corporation) and some tax issues associated with each.

Sole Proprietorship:

Many entrepreneurs start their businesses as sole proprietorship's, where they simply go into business. They may have a web site, business cards and even office space, but the owner and the business are the same legally. This is certainly the simplest way to begin. There are no formalities required. The downside is that all of the owner’s assets can be at risk in a worst-case scenario. Good form contracts and good insurance can reduce many of the business risks.

From a tax perspective, the business profits are reported on the owner’s personal income tax filings, and the income will be taxed at the owner’s standard personal income rate. The owner must file form 1040, and 1040 ES Declaration of Estimated Tax For Individuals. The owner is responsible for paying self-employment taxes. There are many deductions available as well.

Once you hire employees, you should consider forming a limited liability entity to protect yourself from the acts of the employee. There may also be tax savings to forming an entity.