A sole proprietorship, from legal or tax aspects, is not a separate entity but an extension of its owner. The tax advantages of sole proprietorship include: (1) the sole proprietor is taxed at his marginal rate on income, and therefore sole proprietorship might pay less tax than corporation; (2) the owner can withdraw or increase his investment without considering tax consequences. The tax disadvantages of sole proprietorship include: (1) the profits of the business are counted into the taxable income, in regardless of whether the money is withdrawn or used for personal purpose; (2) sometimes corporation tax rate might be lower than individual tax rate. (3) sole proprietorship can not elect for employee compensation deduction.
A partnership is an unincorporated business owned by two or more individuals or entities, in which a group of investors share the benefits and loses of the business. A partnership is a tax reporting entity as a partnership has to file a tax return to report its relevant performance. However, a partnership is not a separate tax paying entity. The individual owner acquires and report the gains and losses of the business directly on individual tax return. Tax advantages of partnership are similar to that of sole proprietorship: the partnership does not pay tax as a separate entity, as the revenues of the partnership are taxed through investors individual tax return. (2) the tax rate of partnership might be lower than corporate tax rate; (3) partners have no need to consider the tax consequences of withdraw or increase their investment; (4) there are no double taxations. Disadvantages are as follow: Partners’ business Earnings are taxed in regardless of distribution;(2) sometimes the individual tax return might be higher than that of corporation rate; (3) no employment compensation deduction available for partnership.
Corporates are separate tax entities. There are two types of corporates, the C Corporates and the S Corporates, both of whose shareholders have limited liability to corporates. Both types of corporates should report results of their operation and income through the Form 1220 (1220S for S-corporates). As for the tax advantages of C-Corporates, (1) shareholders are regarded as employees of a S corporate, and only ought to pay half of the Social Security taxes; (2) shareholders who are regarded as employees can enjoy the tax-free fringe profits; (3) corporates are eligible for electing employment compensation deductions and other deductions; (4) there are other tax related policies encouraging the operation of corporates. However, C-Corporates also have disadvantages on tax. For instance, (1) C-Corporates are double taxed, one for corporate income, while another one for shareholders’ dividends; (2) shareholders must consider tax consequences of withdraw or increase their investments. The S-corporate is more like a partnership, although it generally pays no tax, S-corporate can have heavier tax burden when it generated higher revenues.
When it comes to the choose of organization form, I would recommend clients to select appropriate organizational form according to local/federal requirements and tax policies. For instance, usually corporates have minimum requirements for initial capital. Therefore, sometimes partnership or sole proprietorship might be more suitable than corporates. When taking into consideration of tax advantages, I would recommend clients to establish a corporate so that can enjoy higher tax flexibility and stability.