Proprietorship, corporation or partnership?

Each of these business structures differs in how your profits are taxed and how much liability you must shoulder. Read on to see which works best for you. It’s all in how you structure your business.

The way you conduct business determines how your profits are taxed as well as the nature and magnitude of your benefits – both as an owner and an employee. Let’s examine the various forms of doing business and illuminate the advantages and potential traps with each one.


The simplest form of doing business is as an individual proprietor. Here, you are your business. All revenues are taxed to you and you’re personally liable for any negligence arising from the business operations.

Under a proprietorship, there is no separate business entity. Your profits are reported on the Schedule C attached to your personal 1040 tax return. Most proprietorships simply use the name of the owner as the name of the business. If you don’t want to use your name as the name of the business, that’s OK too. All you have do is file a form called a “fictional name certificate” or a “doing business as” (D.B.A.) certificate with your municipal recorder. It’s usually a simple one-page certificate stating that you, at your address, are doing business as “XYZ” at its address. The form does nothing more than give notice that you are really the business.

The pros:

  • The advantage of the proprietorship form is that it’s easy. No forms or government permission are usually required. You simply declare yourself to be in business.
  • There is no double taxation of your profits. You pay the tax only once, on your personal income tax return. The tax is based on the income of the business, not what you take out of it. For example, if the business earns $100,000, you pay tax on the $100,000. It doesn’t matter if you only took out $80,000 or if you actually took out $110,000. (Your income is calculated after you’ve depreciated items and service, which are considered non-cash expenses. So it’s possible to have more in cash than in actual “income.”) You only pay the tax on the income of the business-$100,000.
  • Note that you get no “deduction” for any salary that you pay yourself. As a proprietor, you get no “salary.” All income, and all expenses, are yours.

The cons:

  • As a proprietor, you must pay twice the amount of Social Security and Medicare taxes that you would as an employee of another entity. For example, for 1998, you must pay 12.4% in Social Security taxes on income up to $68,400, as well as 2.9% in Medicare taxes, with no income limit. If you were an employee, working for someone else or for another entity, you would only have to pay half (a total of 7.65%, rather than 15.3%). Unfortunately, you cannot be an employee of your own proprietorship. However, as a proprietor, you do get a deduction for half of these taxes paid.
  • Proprietorships get no life insurance deduction and a deduction for only part of their health insurance premiums.
  • As a proprietor, you have no liability protection. If you, or anyone working for you, is negligent or is found liable for any act or incident arising from the operations of your business, all of your assets are at risk. This includes both business assets and personal assets. There is no limit to your liability.
  • That’s one reason why many proprietors keep their home and investments in the names of their spouses. Unless the spouse is an owner or commits the “bad act,” those assets are protected from any claims against you. That’s why, as a proprietor, you need some form of errors and omissions insurance. Even if you are not found liable, the legal costs to defend are enormous. The insurance, if purchased right, pays all of those legal costs.


A corporation is a separate legal entity. It is an invisible, intangible entity, recognized only in the contemplation of the law. You can point to the assets of a corporation, but not to the corporation itself.

The pros:

  • A corporation offers limited liability. If a negligent act is committed arising out of the operations of the business, the person who committed the act and the corporation itself is liable.
  • Only corporate assets are at risk. That’s one reason why the owner usually leases assets to the corporation. (The other is to get money out of the corporation without having to pay payroll taxes.) Note, however, that if you are the one committing the negligence, limited liability doesn’t apply. All of your assets, including the corporate stock, are at risk.
  • If you have several employees, your assets are protected from an employee’s mistakes. Moreover, while pension and retirement plan options are about the same as with proprietorships, the corporate form does offer somewhat better employee benefits. For example, health insurance premiums and group life insurance premiums of up to $50,000 in benefits are fully deductible by the corporation and are nontaxable to the employees.
  • Corporate tax rates never climb as high as they do if you’re a sole proprietor. As a proprietor, you pay taxes at a rate of 39.6% on all taxable income in excess of $278,540 on a joint return. The corporate rate doesn’t reach that high. In fact, for between $335,000 and $10 million in taxable income, the marginal rate is only 34%.
  • If you don’t need the money to live on, you can re-invest a lot more of what would have gone to taxes inside the corporate umbrella than outside of it. However, the corporate marginal tax at lower income levels may be higher than your personal rate. Make the comparison.

The cons:

  • Corporations are subject to double taxation. The income of the corporation is taxed once, and again a second time to you as dividends paid out of earnings. Dividends are not deductible corporate expenses.
  • Some advisers suggest zeroing out the corporation by paying enough salary and bonus to have a zero corporate income. Here, your compensation is deductible by the corporation, but it has to match your Social Security and Medicare payments. If you are the sole owner (shareholder), you end up paying the same as a proprietor, except it comes out of two different pockets.
  • If you are the sole owner, and the sole employee of a corporation, this form may give you little in benefits in exchange for a ton of new paperwork.

Alternative entities

There are several other forms of doing business. For example, you can operate as a partnership. With a general partnership, all income is taxed proportionately to each of the partners. There is no double taxation, but there also is no limited liability. Limited partnerships offer limited liability to the limited partners, but these partners must give up any voice in the management or control of the partnership.

Alternatively, you can do business as an S Corporation. This is a corporation that has elected to be taxed like a partnership. Here we have both no double taxation and limited liability. S corporations are limited to only 75 shareholders, and those owning 5% or more in stock have limited employee benefits.

For those needing more than 75 owners, we have limited liability companies and limited liability partnerships. In both cases, limited liability is coupled with single taxation.

Often since the stakes are high and the details abundant, you may wish to consult with an attorney or CPA who specializes in this area to review your specific situation.

See also…

Starting a Business