Software Club 210: Light Red/Club_Software_210_Light_Red_Micro_Star_1997.iso/sba/f110.sbe

Text File | 1997-01-01 | 13KB | 263 lines

@185 CHAP 2

      ┌───────────────────────────────────────────────────┐
      │SOLE PROPRIETORSHIPS:  ADVANTAGES AND DISADVANTAGES│
      └───────────────────────────────────────────────────┘

The great advantage of operating a new business as a sole
proprietorship is that it is simple and does not require
any formal action to set it up.  You can start your business
today as a sole proprietor -- there is no need to wait for
an attorney to draft and file documents or for the government
to bless them.  Of course, you will need a business license
in most cases -- and a few states will require even a
sole proprietor to register in order to do business legally.
@IF901xx]Since your business is not in existence yet, the relative
@IF901xx]simplicity of starting out as a sole proprietorship is one
@IF901xx]key factor you may want to keep in mind when you start up
@IF901xx]your firm, @NAME.
@IF901xx]
@IF115NV]For example, Nevada requires that your sole proprietorship,
@IF115NV]@NAME, obtain a license.
@IF115WA]For example, the state of Washington requires that your sole
@IF115WA]proprietorship, @NAME, be licensed --
@IF115WA](in all but in a very few instances).

Another advantage of a sole proprietorship is that you can
shift funds in and out of your business account or withdraw
assets from the business with few tax, legal, or other
limitations.  By contrast, in a partnership you can generally
withdraw funds only by agreement, and in the case of a
corporation, a withdrawal of funds or property will usually
be taxable as a dividend or capital gain and may even violate
the state's corporation laws in some instances.

@IF121  ]NOTE:  Because your business is a corporation, you could
@IF121  ]incur a substantial taxable gain if you were to "liquidate"
@IF121  ]in order to turn it into an unincorporated form of business
@IF121  ]entity.  The taxable gains could either be incurred by the
@IF121  ]owner(s), by @NAME, or by both.
@IF121  ]
@IF121  ]In short, it is much easier to get INTO a corporation, than
@IF121  ]to get out of one.
@IF121  ]
A sole proprietor is the sole owner of his or her business.
If married, however, one's spouse will usually have a
one-half ownership interest in the business in any of the
nine states which currently have community property laws.
@CODE: CA AZ NM NV WA ID TX LA
@STATE is one of the states that has community
property laws.
@CODE:OF
@CODE: WS
(Wisconsin adopted a community property system of marital
property law in 1986.)
@CODE:OF

As the owner of the business, the sole proprietor is
personally liable for any debts or taxes of the business
or other claims (such as legal damages resulting from a
lawsuit).  This is one reason why many entrepreneurs who
have substantial wealth that could be lost if their business
were to fail often prefer to use a corporation rather than a
proprietorship or partnership.  Unlimited personal liability
is perhaps the major disadvantage of operating a business in
the form of a sole proprietorship.

All of the profit or loss from a sole proprietor's business
is taxed to the owner and must be reported on the owner's
federal income tax return, usually on "Schedule C, Income
(or Loss) from a Business or Profession" of their Form
1040.  (Farmers generally report income on Schedule F.)
This can be an advantage, tax-wise, since any losses
(unless the losses are from what is considered to be a
"passive activity") should be deductible against other
income of the owner.

On the other hand, if there is a profit, the income may be
taxed at a lower rate than in an incorporated business,
since corporate rates are generally lower than individual
federal income tax rates.  The maximum corporate rate is
34% (35% on taxable income over $10 million) vs. a maximum
individual tax rate of 39.6% on taxable income of over
$250,000.  (At certain "phase-out" levels of income, the
corporate rates go up to 39% and individual rates to somewhat
over 40%, depending on the number of personal exemptions
phased-out, itemized deductions phased-out, etc....)

For certain professionals, such as lawyers, physicians,
accountants, architects, etc., whose corporations are
subject to a flat tax rate of 35% if incorporated, the sole
proprietorship is often a much more attractive legal form of
doing business.  Since the former advantages of corporate
pension and profit sharing plans vs. Keogh plans for
unincorporated firms are now virtually non-existent, and
since professional corporations provide little or no
protection from malpractice liability in most states, there
are fewer and fewer reasons for professionals to incorporate
since the 1986 Tax Reform Act went into effect.

However, sole proprietorships do have some tax disadvantages.
For one thing, with a sole proprietorship you don't have a
separate taxpayer entity with which you can split income, as
is possible if you are incorporated.  (A C corporation, by
contrast, can still be used to split income between owner
and corporation.  For example, if the business generates a
$150,000 overall profit, and the profit can be split evenly
between owner and corporation by having the owner draw out
$75,000 of salary for the year, there will be a considerably
lower tax bite, taking advantage of the lower tax brackets
for both the individual and the corporation, than if all the
income is taxed to the owner as a sole proprietor.)

Let us look at 3 examples, assuming in each that you are
married, your spouse earns a salary of $20,000 a year from
a job with an unrelated company, and you have no other
income, deductions (other than the standard deduction) or
dependent exemptions.  You and your spouse file joint
returns.  If you had no income, the tax on your spouse's
income alone would be $1,268 (ignoring any FICA tax on his
or her income).

      ┌───────────────────────────────────────────────────┐
      │ EXAMPLE 1:    Your business  generated an  annual │
      │ profit of $50,000 in 1995.  As a sole proprietor, │
      │ you would pay joint income taxes of $10,307, plus │
      │ self-employment tax on $46,175 of net S/E income, │
      │ or $7,065 ($50,000 - 3825 = $46175) (assuming the │
      │ income of the business is self-employment income) │
      │ so that the total tax liability is $17,372.   If, │
      │ instead, your business were a C corporation  (but │
      │ not a "qualified  personal  service  corporation" │
      │ subject to a flat 35% tax rate) and you drew only │
      │ a  $25,000 salary,  the corporation  is left with │
      │ $25,000 of taxable income,  less $1,913  FICA tax │
      │ it must pay on your salary, or $23,087 net.  Thus │
      │ the corporation would pay a corporate  income tax │
      │ of 15% of $23,087, or $3,463, and your individual │
      │ income tax would be  $5,018.  Accordingly, if you │
      │ had incorporated,  total tax liability  would be: │
      │                                                   │
      │           Corporate income tax           $ 3,463  │
      │           Personal income tax              5,018  │
      │           FICA (on you and corp.)          3,825  │
      │                                           ------  │
      │           Total current tax liability    $12,306  │
      │                                           ======  │
      └───────────────────────────────────────────────────┘

       Thus, in this example, using a "C" corporation
       to split income would save $5,066, or over 29%, in
       current taxes, as compared to a sole proprietorship.
       (Note that even if the corporation were subject to
       the flat 35% tax rate as a "personal services
       corporation," there would still be a tax savings of
       $2,004 in the above 1995 example.)

      ┌───────────────────────────────────────────────────┐
      │ EXAMPLE 2:  Let's assume in this example that your│
      │ business earns $150,000. As a sole proprietorship,│
      │ you and your spouse's  total tax would be  $39,875│
      │ of income tax and  $11,606 of self-employm