New business owners always seem to wring their hands over
the incorporation question. Should they, or shouldn't they,
incorporate their new business. Or, no, wait. Maybe an S
corporation or limited liability company makes more sense?
This obsessing over more sophisticated (and expensive!)
entity options is too bad, however. New small business
owners can count at least five great reasons to start a
small business as a sole proprietorship.
Reason 1: Simple Setup
As compared to incorporating or forming a limited liability
company, sole proprietorships are a breeze. All you really
need to do is start. That's it.
Note: State and local governments often want you to get a
business license so they can get your new business on their
business tax rolls. But getting a business license in many
cases is pretty easy. Check the phone book or call your
local state or municipal government offices.
Reason 2: Easier Accounting
If you run your business as a sole proprietorship, you keep
your accounting truly easy. If you're the only worker, you
won't even have to do payroll. Not having to do payroll
saves tons of time, lots of money, and means you avoid
doing between five and ten payroll tax returns a year:
quarterly federal and state returns, the annual federal
unemployment tax return, W-2s, and so forth.
What's more, you won't have to prepare balance sheets as
part of your business tax return. Your sole
proprietorship's income and deductions will typically be
reported inside your individual tax return on a single page
of paper.
In comparison, corporations and partnerships often do have
to prepare balance sheets for their tax returns and a
boatload of other supporting schedules. Commonly a
corporate tax return runs between ten and twenty pages in
length. Yikes.
Reason 3: Minor Children as Tax Shelters
If you employ your minor children in your business, a sole
proprietorship offers up one of the sweetest small business
shelters there is. Amounts you pay your minor children
count as a tax deduction for your business--which saves you
income taxes and self-employment taxes. But the amounts
your minor children earn probably aren't taxable to them
for either income tax or Social Security and Medicare taxes
purposes if they make less than the standard deduction
amount.
Note: The standard deduction amount equals $5450 in 2008.
In the years after 2008, the standard deduction increases
because of inflation.
The ability to employ minor children, take the tax
deduction on your tax return, and then let the kids avoid
income and payroll taxes could save your family almost
$3,000 in taxes per year per kid working in the family
business. Wow.
A final caution: The kids need to be doing real work and be
paid a reasonable wage.
Reason 4: Easy Deductibility of Health Insurance
Sole proprietors can more easily take a deduction for
family health insurance. The rules are a wee bit tricky.
The family can't be receiving subsidized health insurance
from, say, a previous or current employer. And you get the
health insurance deduction only to the extent that the
business enjoys profits.
Nonetheless, sole proprietors will often be able to deduct
their health insurance. (Normal employees typically can't.)
And sole proprietors can much more easily take the
self-employee deduction than corporation
shareholder-employees and partners in partnerships.
Note: Technically, the self-employed health insurance
deduction is available to S corporation
shareholder-employees and partners in partnerships, but the
rules for taking the deduction are more complicated and
tend to change from year to year. Ugh.
Reason 5: Future Flexibility
One final reason exists for considering the
under-appreciated sole proprietorship option. With a sole
proprietorship, you can easily switch to some other form at
a later date--and almost always with zero negative tax
consequences.
With a sole proprietorship, for example, you can decide in
year two or three that you want to incorporate your
business or reform as a limited liability company. No
problem. What's more, at that point, you can decide whether
the S corporation option makes sense.
A sole proprietorship, then, lets you keep things simple
now while also keeping open your future options.
In comparison--and this is especially true with
corporations and somewhat true with limited liability
companies--reforming other business entities takes time and
can cost lots of money (including taxes).
----------------------------------------------------
Stephen L. Nelson is a Seattle area CPA and the author of
numerous how-to books about small business accounting. He
also edits the do-it-yourself web sites:
http://www.fasteasyincorporationkits.com and
http://www.llcsexplained.com .
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