Sole Proprietorship: The Type of Business Entity

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Table of Contents

Liability Issues for a Sole Proprietorship
Tax Effects of the Business Entity
Economic Impacts on the Client’s Returns
Recommendation on the Daughter’s Interest
References

While there are several business types, the form I recommend to Mr. X is the sole proprietorship. The business entity is suitable considering the tax implications as the business owner receives all the income or losses incurred on the tax returns in an arrangement called pass-through taxation (Kasahun, 2020). A sole proprietor is entitled to tax refunds when the estimated amount of tax paid throughout the year exceeds tax liability based on the company’s overall profits and losses. Therefore, operating as a sole proprietor makes the owner self-employed for tax purposes and responsible for reporting all incomes and losses in the company (Dungan, 2017). Other business types, including partnerships and limited companies require more capital to start, involve external parties, increased paperwork, and extended application period. On the contrary, starting a sole proprietorship is an effortless and easily affordable process.

Liability Issues for a Sole Proprietorship

Sole proprietors are personally held accountable for lawsuits, charges, and other commissions easily encountered in doing the job. Therefore, a sole owner would no longer have their property if the trade does not operate under the required standards (Kim et al., 2020). Additionally, the owner does not have limited liability since there is no difference between the owner and the business, which means that creditors can recover their money from the owner’s business and personal assets (Kasahun, 2020). Therefore, it is advisable that Mr. X properly manages the business entity to avoid court cases and protect his wealth (Dungan, 2017). With this type of business entity, the capacity to raise capital is limited, which will adversely affect its future development and growth. According to internal revenue code 26 CFR § 1.1001-2 on discharge of liabilities, Mr. X would pay taxes on any amounts realized from the sale of property based on personal liability terms (26 CFR § 1.1001-2, n.d.). However, he can always change to another type in the future as the need arises.

Tax Effects of the Business Entity

Due to sole proprietorship’s simplicity, taxes are not separated since the owner reports the financial gains and losses encountered. Mr. X will file income tax, self-employment tax, estimated tax, and social securities and Medicare tax (Internal Revenue Service (IRS), 2020). However, a sole proprietor is disadvantaged due to unlimited personal liability, self-employment tax, and difficulty raising capital (Kasahun, 2020). Also, owners must pay the entire amount themselves, although they can deduct half of the cost. They are entitled to tax refunds on the tax payments, which may, in turn, increase the profit margins of the business (Kim et al., 2020). Income for sole proprietorships is addressed on Schedule C, which is part of the owner’s tax return Form 1040. This form of a sole proprietorship is personally liable for its debts and actions since it lacks the desired entity.

Economic Impacts on the Client’s Returns

After the deductions are made in the business expenses on Form 1040 Schedule C for sole proprietors, the remaining profit is considered personal income. These increased profit margins can boost the economy through taxation and utilized by the sole proprietor to expand the business. Additionally, the sole proprietor can make use of the same amount of money to hire employees and pay their salaries (Kasahun, 2020). Partnerships would involve sharing profits with partners at agreed percentages, while incorporated business types involve higher legal fees and extensive paperwork during registration and tax filing. These entities, such as public companies, might also need publishing of financial statements.

Recommendation on the Daughter’s Interest

The client’s daughter cannot be part of the company’s business owners since the control of a sole proprietorship is just done by one person. Although the client’s daughter can easily protect the sole proprietorship’s name, there is a limit of one on ownership (Kasahun, 2020). As a result, the daughter’s interest in ownership lacks relevance for this business type. However, there is no limit to the number of people hired to work for the sole proprietorship. Therefore, the daughter can benefit from working with Mr. X at the company; this increases the profit margins and personal returns.

References

26 CFR § 1.1001-2 – Discharge of liabilities. (n.d.). Cornell Law School. Web.

Dungan, A. (2017). Sole proprietorship returns, tax year 2015. IRS Statistics of Income. Web.

Internal Revenue Service. (2020). Sole proprietorships. Web.

Kasahun, A. K. (2020). The impact of working capital management on firms’ profitability-case of selected sole proprietorship manufacturing firms in Adama City.IOSR Journal of Economics and Finance (IOSR-JEF), 11(1), 45-55. Web.

Kim, H. J., Lee, B. K., & Sohn, S. Y. (2020). Comparing spatial patterns of sole proprietorship and corporate payday lenders in Seoul, Korea.The Annals of Regional Science, 64(1), 215-236. Web.

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Sole Proprietorship: The Type of Business Entity

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