home
***
CD-ROM
|
disk
|
FTP
|
other
***
search
/
Cream of the Crop 1
/
Cream of the Crop 1.iso
/
BUSINESS
/
SBA62.ARJ
/
FSBA.EXE
/
F110.SBE
< prev
next >
Wrap
Text File
|
1992-04-30
|
11KB
|
196 lines
@185 CHAP 2
┌───────────────────────────────────────────────────┐
│SOLE PROPRIETORSHIPS: ADVANTAGES AND DISADVANTAGES│
└───────────────────────────────────────────────────┘
"Being boss doesn't make you right; it just makes
you boss." -- Milton Metz
The great advantage of operating a new business as a sole proprietor-
ship 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 li-
cense in most cases -- and a few states require even a sole proprietor
to register in order to do business legally.
Another advantage of a sole proprietorship is that you can shift funds
in and out of your business account or withdraw assets from the busi-
ness 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 usu-
ally be taxable as a dividend or capital gain and may even violate the
state's corporation laws in some instances.
A sole proprietor is the sole owner of his or her business. If mar-
ried, however, one's spouse will usually have a one-half interest in
the business in any of the states which have community property laws.
@CODE: CA AZ NM NV WA ID TX LA
@STATE is one of the nine states having 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 entre-
preneurs who have substantial wealth that could be lost if their busi-
ness were to fail prefer to use a corporation rather than a proprietor-
ship or partnership. Unlimited personal liability is perhaps the major
disadvantage of operating a business in the form of a sole proprietor-
ship.
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 re-
turn, usually on "Schedule C, Income (or Loss) from a Business or Pro-
fession" of their Form 1040. (Farmers generally report income on
Schedule F.) This can be an advantage, tax-wise, since any losses (un-
less the losses are from what is considered to be a "passive activity")
should be deductible against other income of the owner. Similarly, if
there is a profit, the income may be taxed at a lower rate than in an
incorporated business, since corporate rates are now higher than indi-
vidual federal income tax rates. The maximum corporate rate is 34% vs.
a maximum individual tax rate of 31% on high levels of income. (At
certain "phase-out" levels of income, corporate rates go up to 39% and
individual rates to 32% or somewhat more, depending on number of
personal exemptions phased-out, itemized deduction phased-out, etc.)
For certain professionals, such as lawyers, physicians, accountants,
architects, etc., whose corporations are subject to a flat tax rate of
34% if incorporated, a sole proprietorship is now generally a much more
attractive legal form of doing business. Since the former advantages
of corporate pension and profit sharing plans vs. Keogh plans for unin-
corporated firms are now virtually non-existent, and since professional
corporations usually do not provide protection from malpractice liabil-
ity 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 in-
corporated. (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 $75,000 of sal-
ary 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 $1,500 (ignoring any FICA tax on her income).
┌───────────────────────────────────────────────────┐
│ EXAMPLE 1: Your business generated an annual │
│ profit of $50,000 in 1991. As a sole proprietor, │
│ you would pay joint income taxes of $11,391, 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 $18,456. If, │
│ instead, your business were a C corporation (but │
│ not a "qualified personal service corporation" │
│ subject to a flat 34% tax rate), and you drew on- │
│ ly 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 $23,122 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 $5,380. Accordingly, if you │
│ had incorporated, total tax liability would be: │
│ │
│ Corporate income tax $ 3,463 │
│ Personal income tax 5,380 │
│ FICA (on you and corp.) 3,825 │
│ ------ │
│ Total current tax liability $12,668 │
│ ====== │
└───────────────────────────────────────────────────┘
Thus, in this example, using a "C" corporation
to split income would save $5,788, or over 30%, in
current taxes, as compared to a sole proprietorship.
(Note that even if the corporation were subject to
the flat 34% tax rate, there would still be a tax
savings of $1,390.)
┌───────────────────────────────────────────────────┐
│ 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 $41,447│
│ of income tax and $10,247 of self-employment tax,│
│ or a total of $51,694. If you were incorporated│
│ and took out half of the corporate pre-tax profit│
│ of $150,000 as a $75,000 salary, the corporation's│
│ 1991 taxable income would be $75,000 - FICA tax of│
│ $4,398 = $70,602. At the graduated corporate tax│
│ rates of only 15% on the first $50,000 and 25% up│
│ to $75,000, the corporate tax would be $12,651 and│
│ your individual income tax would be $19,464. Ac-│
│ cordingly, if incorporated, the total tax liabil-│
│ ity would have been as follows: │
│ │
│ Corporate income tax $12,651 │
│ Personal income tax 19,466 │
│ FICA (on you and corp.) 8,796 │
│ ------ │
│ Total current tax liability $40,913 │
│ ====== │
└───────────────────────────────────────────────────┘
Thus, in this example, using a "C" corporation
to split income would save $10,781, or more than
20%, in current taxes, as compared to a sole
proprietorship. (But note that in this case, if
the corporation were subject to the flat 34% tax
rate, there would be a $573 tax DISadvantage if
incorporated, versus doing business as a
proprietorship.)
┌───────────────────────────────────────────────────┐
│ EXAMPLE 3: Assume this time that you really hit │
│ it big, and that the business made $500,000 pre- │
│ tax in 1991, before paying you a salary of, say, │
│ $100,000. This time (regardless of whether the │
│ corporation is a "qualified personal service │
│ corporation") the total current tax liability is │
│ $171,119 if incorporated, versus $161,207 if you │
│ had remained a sole proprietor. Thus, at this │
│ high income level, being a corporation COSTS you │
│ almost $10,000 in additional federal tax, rather │
│ than saving taxes! │
└───────────────────────────────────────────────────┘
Note that the three foregoing examples only compare CURRENT tax
liability. Where a corporation is used to split income, the net
income that is left in the corporation (net of tax paid on it) MAY
result in additional individual tax at some indeterminate time in
the future, if paid out as a dividend or in liquidation, or if the
stock is sold. Where this double taxation occurs in the near future,
the advantages of income-splitting in Examples 1 and 2 may be less-
ened, or even non-existent, so you should understand that income-
splitting with a corporation is largely a matter of tax DEFERRAL and
not tax SAVING, for the most part.
Another DISadvantage of sole proprietorships (and partnerships and S
corporations) is that they cannot obtain a number of significant tax
benefits regarding:
. Group term life insurance coverage;
. Long-term disability and accidental death insurance; and
. Medical insurance and medical expense reimbursement plans.
To qualify for favorable tax treatment (i.e., deductibility) in con-
nection with such "fringe benefit" plans, it is necessary to operate
as a C corporation.