Advantage and disadvantage of sole proprietorship partnership and corporation

The most important advantages - and disadvantages - of corporations over partnerships and sole proprietorships.

Corporations enjoy many advantages over partnerships and sole proprietorships. But there are also disadvantages. We cover the most important ones below.

Advantages:

Stockholders are not liable for corporate debts. This is the most important attribute of a corporation. In a sole proprietorship and partnership, the owners are personally responsible for the debts of the business. If the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner's personal bank account, house, etc. to make up the difference. On the other hand, if a corporation runs out of funds, its owners are usually not liable.

Please note that under certain circumstances, an individual stockholder may be liable for corporate debts. This is sometimes referred to as "piercing the corporate veil." Some of these circumstances include:

• If a stockholder personally guarantees a debt.
• If personal funds are intermingled with corporate funds.
• If a corporation fails to have director and shareholder meetings.
• If the corporation has minimal capitalization or minimal insurance.
• If the corporation fails to pay state taxes or otherwise violates state law (like defrauding customers).

Self-Employment Tax Savings. Earnings from a sole proprietorship are subject to self-employment taxes, which are currently a combined 15.3% on the first $97,500 of income for tax year 2007. With a corporation, only salaries (and not profits) are subject to such taxes. This can save you thousands of dollars per year.

For example, if a sole proprietorship earns $80,000, a 15.3% tax would have to be paid on the entire $80,000. Assume that a corporation also earns $80,000, but $40,000 of that amount is paid in salary, and $40,000 is deemed as profit. In this case, the self-employment tax would not be paid on the $40,000 profit. This saves you over $5,000 per year. Please note, however, that you should pay yourself a reasonable salary.

Continuous life. The life of a corporation, unlike that of a partnership or sole proprietorship, does not expire upon the death of its stockholders, directors or officers.

Easier to raise money. An corporation has many avenues to raise capital. It can sell shares of stock, and it can create new types of stock, such as preferred stock, with different voting or profit characteristics. Plus, investors be assured that they are not personally liable for corporate debts.

Ease of transfer. Ownership interests in a corporation may be sold to third parties without disturbing the continued operation of the business. The business of a sole proprietorship or partnership, on the other hand, cannot be sold whole; instead, each of its assets, licenses and permits must be individually transferred, and new bank accounts and tax identification numbers are required.

Disadvantages

Higher cost. Corporations cost more to set up and run than a sole proprietorship or partnership. For example, there are the initial formation fees, filing fees and annual state fees. These costs are partially offset by lower insurance costs.

Formal organization and corporate formalities. A corporation can only be created by filing legal documents with the state. In addition, a corporation must adhere to technical formalities. These include holding director and shareholder meetings, recording minutes, having the board of directors approve major business transactions and corporate record-keeping. If these formalities are not kept, the stockholders risk losing their personal liability protection. While keeping corporate formalities is not difficult, it can be time-consuming. On the other hand, a sole proprietorship or partnership can commence and operate without any formal organizing or operating procedures - not even a handwritten agreement.

Unemployment tax. A stockholder-employee of a corporation is required to pay unemployment insurance taxes on his or her salary, whereas a sole proprietor or partner is not. Currently, the federal unemployment tax is 6.2% of the first $7,000 of wages paid, with a maximum of $434 per employee.

If you pay any required state unemployment tax, you can receive an offset credit of 5.4%, effectively lowering the federal rate to 0.8%, for a maximum of $56.00 per employee per year.

In the United States, there are several types of structures available to a single-owner business, including sole proprietorship, C corporation, S corporation, and limited liability company (LLC).

The type of business entity you choose can impact everything from how you pay your taxes to the amount of paperwork you have to fill out to whether you can bring on investors or not. One of the most common business structures is a sole proprietorship, which many individuals running small businesses use, including freelance graphic designers and computer programmers.

What is a sole proprietorship?

A sole proprietorship is an unincorporated business owned by one person. At its core, there is no real distinction between the owner of a sole proprietorship and the business itself. Because of that, a sole proprietor has unlimited personal liability. That means your personal assets—your house, personal bank accounts—are also at risk if a claim is made against the business (e.g., through a lawsuit) or you have to pay back business debts.

On the flip side, filing taxes is relatively painless because of the simplicity of the business structure. As a sole proprietor, you file your business income on your personal income tax return.

What are the advantages of a sole proprietorship?

A sole proprietorship is the simplest of all the structures for a single-owner business. Your business is automatically considered a sole proprietorship without having to incorporate your business. However, you must apply for any licenses or permits that your state requires for your profession.

As the owner, you are responsible for all business debts, losses, and liabilities, but are also entitled to all the business profits, too. Other advantages include:

1. Ease. Because there is no formal action required to form a sole proprietorship, owners can save money and time that would otherwise be spent fulfilling paperwork requirements.
2. Complete control. As the sole proprietor, the owner can make all the decisions about the business without partners or shareholders to consult.
3. No corporate tax payments. Instead of completing corporate income like a large corporation would, sole proprietorships require the owner to pay only personal income taxes. You simply have to attach a Schedule C to your 1040 form.
4. Inexpensive. While sole proprietors must abide by licensing requirements designated by the states where they work, other paperwork and formalities are limited. As a result, it’s less costly to start than a corporation. Costs to forming a sole proprietorship typically come when filing taxes, as you might need to enlist the help of a tax professional.

What are the disadvantages of a sole proprietorship?

Here are some of the drawbacks to the sole proprietor business structure:

• Debts, duties, and obligations all on you. As the sole proprietor, you are solely responsible for paying all the company’s debts and obligations. That’s true even if an employee or contractor causes the issue.
• Unlimited personal liability. Not only can someone make a claim—such as in a lawsuit—against your business assets, they can also make a claim against your personal assets, like your home. Unlike other business structures, a sole proprietorship doesn’t protect your personal assets from creditors.
• Capital contributions. As a sole proprietor, you’re responsible for paying for all the capital needs—office equipment, for example—of the business. You may also find it harder to get a loan from a bank, since lenders typically view sole proprietor businesses as risky investments.
• Lack of investors. Investors usually bypass opportunities to invest in sole proprietorships because they want to receive equity in exchange for their money. Because a sole proprietor can have only one owner, there is no possibility to distribute equity.
• Increased taxes. As a sole proprietor, you have to pay self-employment tax on top of personal income tax. It can also be trickier to figure out how much you will owe in taxes because you are combining business and personal taxes. To avoid paying a larger-than-expected tax bill at the end of the year, the IRS recommends estimating and paying your taxes quarterly.

Starting out as a sole proprietor is a good way to test the waters as an entrepreneur since there is very little investment in both time and money to this type of business entity.

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