Choosing a Small Business Structure Sole Propreitorship

By | November 24, 2015

When starting a business, you must determine your business structure. In this webinar, we’re focusing on sole proprietorship.If you are a one-person business, you are automatically classified as a sole proprietor for Federal tax purposes unless you file Form 8832, Entity Classification Election, to request a different classification.


What is considered a business by the IRS?

You carry on a trade or business as a sole proprietor or an independent contractor, and you are otherwise in business for yourself including a part-time business. A sole proprietor is someone who owns an unincorporated business by him or herself. People such as doctors, daycare providers, mechanics, and contractors who are in an independent trade, business, or profession in which they offer their services to the general public are generally considered independent contractors.However, whether these people are independent contractor or employees depends on the facts in each case.


Who is an independent contractor?

The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the results of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to self-employment tax.A trade or business in which you participate on a regular, continuous basis with the intent of making a profit is generally an activity. The facts and circumstances of each case determine whether or not an activity is a trade or a business. Regular activities and transactions that produce income are important elements. You do not need to actually make a profit to be in a trade or business, as long as you have a profit motive. You do need, however, to make ongoing efforts to be profitable. You do not have to carry on regular, full-time business activities to be self-employed.Having a part-time business in addition to your regular job may be considered self-employment.


Example of Independent Contractor

For example, you are employed full-time as an engineer at the local plant; and you fix televisions and radios during the weekend. You have your own shop, equipment, and tools. You get your customers from advertising and word of mouth. You are considered to be self-employed as the owner of a part-time repair shop.


What is a sole proprietorship for IRS Tax Purposes?

A sole proprietorship is an unincorporated business owned by one person. It is the simplest type of business organization. The business does not exist apart from the owner. As the business owner, you assume risk of the business to extend to all of your assets, even if you don’t use your personal assets in the business. Usually the ability to finance the business, known as capital, is limited to the amount the owner can come up with. This may limit the expansion of the business when new capital is required. Common cause of failure of sole proprietors is the lack of capital. The exception to a sole proprietorship being a one-person business is a qualified joint venture; that’s next.


What is an IRS qualified joint venture?

What is a qualified joint venture? It’s when both spouses have an equal say in the affairs of the business, provide substantially equal services to the business, and contribute capital to the business. This used to be called a partnership.Now spouses can elect to be treated as a qualified joint venture. A qualified joint venture is a joint venture involving the conduct of a trade or business if the only members of the joint venture are husband and wife,and both spouses materially participate in the trade or business and both spouses elect to have the provision apply.


What is material participation in the qualified joint venture?

Materially, participation means working on a regular, continuous, and substantial basis in the business. In a qualified joint venture, all items of income, gains, loss, deduction, and credit are divided between the spouses in accordance with their respective interests in the venture. Each spouse takes into account his or her respective share of these items as the sole proprietor. For the purposes of determining net earnings from self-employment, each spouse’s share of income or loss from a joint venture is taken into account, just as it is for Federal income tax purposes. This generally does not increase the total tax on a return, but it does give each spouse credit for Social Security earnings on which retirement benefits are based.


Spouses on Form 1040 with business

Spouses make the election on a jointly filed Form 1040 by dividing all items of income, gain, loss, deduction, and credit between them in accordance with each spouse’s respective interest in the joint venture.Each spouse files a separate Schedule C and Schedule SE with the Form 1040. A business owned and operated by the spouses through a limited liability company does not qualify for the election. Only businesses that are owned and operated by spouses as co-owners qualify for the election. If all this sounds too complicated for you, consider finding a tax preparer to assist you in fling your Federal tax return. However, you are legally responsible for what’s on your own tax returns even if they’re prepared by someone else.