Barry and Howard
PSB Tax & Bookkeeping Service
Due to a typesetting error, last month's Tax Tips made an incorrect statement regarding personal liability. The article should have stated, "You cannot simply file Articles of Incorporation within the state and expect to avoid personal liability." The article incorrectly states, "You can simply file Articles of Incorporation within the state and expect to avoid personal liability."
Last issue we discussed incorporating and its implications. Incorporating may not be for everyone. You have other choices. This issue we are going to discuss sole proprietorships and partnerships.
A sole proprietorship is the most widely used form of operating entity in business. It is the simplest and the easiest. You need only one bank account which means that you can mix your personal and business dollars. However, we recommend that you have a separate business account. Bookkeeping is simple, in that you only have to record your income and expenses. You do not have to account for your assets or liabilities. As far as the owner-operator is concerned, he/she must keep track of the money received and all expenses in connection with the business. Only one income tax return is required when operating as a sole proprietor. The income from your business is reported on your personal tax return on a Schedule C (Profit or Loss of Business). There are no payroll requirements for the owners of a sole proprietorship since they simply write checks or withdraw money as needed. However, you will need to make estimated tax payments in order to prevent penalties and interest. When you purchase your equipment, it is written off through depreciation and is deducted on the Schedule C.
There are numerous factors to consider before deciding to be a sole proprietor. One, you could suffer illness or injuries which can prevent you from bringing in an income. It will be difficult to find someone to take up the slack. You would probably have to hire a driver temporarily. To protect yourself against the occurrence of injury or illness, you should take out a disability insurance policy. You should also check out business interruption insurance since all responsibilities rest on your shoulder. As a sole proprietor, you are responsible for 100 percent of the decisions. You are in control.
Another form of business operating entity is the partnership. The partnership has two or more owners, and they do not have to be equal nor do they have to share equally in the profits. The partnership is a separate entity and needs its own bank account. The bookkeeping requirements are more complex than those of a sole proprietorship but less stringent than those of a corporation. The partnership requires its own tax return: Form 1065. The income from a partnership is reported on a Schedule K-1 (Partner's Share of Income, Credits, Deductions, etc.) Like the sole proprietorship, there are no payroll requirements for the partners. The money is taken out as needed, which is known as partnership draw. You need to make estimated tax payments to prevent penalties and interest.
There are similar factors to consider when you are in a partnership when comparing it to a sole proprietorship, such as illnesses and injuries. If you suffer injury or illness, you then have a partner to help run the business. You should still purchase disability insurance to protect yourself in case of injury or illness. In a partnership, you are sharing the responsibility with someone else so you don't have 100 percent of the burden on your shoulders.
Remember, you do have a partner and there can be differences of opinion concerning methods of operation. You should have a written partnership agreement.
This agreement should include language on how the profits are to be divided, the percentage of ownership and buyout provisions. Address the possibilities of long-term absences due to illness and injury. Problems can also arise when one partner decides to leave the partnership. There should be buyout provisions to cover the inevitability of a partner leaving. If one partner has a larger ownership interest than another, for example 60 percent to 40 percent, the one with 60 percent then has the power to make all final decisions.
Future segments will discuss Limited Liability Corporations and Corporations. LL
This article has been presented by PBS Tax & Bookkeeping Service. If you would like further information, please contact Barry or Howard at 800-697-5153. See our website at www.pbstax.com.