If you were starting a business, what tax considerations might cause you to prefer to set...

If you were starting a business, what tax considerations might cause you to prefer to set it up as a proprietorship or a partnership rather than as a corporation?

Expert Solution

When starting a new business, many of the most important decisions owners make are not directly related to the products or services they plan to sell. Businesses can have several different legal structures which impact how owners earn income and how the business is taxed. Partnerships and corporations are two common types of businesses which are subject to different tax laws.

Partnership Tax Rules

A partnership is a business structure where ownership and management responsibility of a company is split between two or more individuals. A partnership is not a legal entity that is separate from the owners and therefore the partnership itself does not pay taxes. The Internal Revenue Service says that under a partnership structure, the profits a business earns flow directly to the personal income tax returns of the owners. For example, if a partnership with two owners makes $500,000 in profit and the owners split profits equally, each would have to report $250,000 in income on their personal tax returns. Partners are responsible for paying self-employment taxes on business income.

Corporation Tax Rules

A corporation is a business that is owned by a group of shareholders who purchase stock in the company. A corporation is a legal entity that is separate from the owners for tax purposes. According to the IRS, the corporations pay income taxes on profits when they are earned. Unlike the owners of partnerships, shareholders are not responsible for paying taxes on the profits a corporation earns. Shareholders of corporations are not subject to self-employment taxes.

Liability of Owners

Another major difference between corporations and partnerships is the liability of owners for the debts of the business. In partnerships, owners are legally liable for the debts of the business. If a partnership fails, partners may have to pay back creditors with their own personal resources. The shareholders of corporations are not liable for a corporation's debts. In other words, if a corporation goes out of business, shareholders are not responsible for the debts or taxes the corporation owes.

Considerations

A dividend is payment of cash or stock that a corporation pays to shareholders. While the shareholders of corporations do not pay taxes on corporate profits, they do pay taxes on profits that the corporation distributes as cash dividends. In addition, if a shareholder sells shares of stock in a company that have increased in value over time, he must pay capital gains tax on the profit realized from the sale of stock.

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jeff jeffy answered 2 years ago

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