Category: Small Business Assistance

Sole Proprietorship or Partnership? Navigating Schedule C vs. Form 1065 for Your Startup

The choice of legal structure is a pivotal decision when establishing a new business.  Many business owners opt for a limited liability company or a corporation.  This decision is primarily driven by two factors: (1) the legal structure that offers the most favorable income tax rates and (2) the potential involvement of investors who may seek an equity stake in the business.  These considerations are best discussed with an accountant or lawyer.

Most of our clients establish their businesses as limited liability companies (LLCs) due to the ease of filing the required paperwork.  If there is more than one owner, the LLC will be a partnership in the eyes of the IRS.  If there is only one owner, the IRS views the business as a sole proprietorship, and the owner can file a Schedule C for the business.

Often, clients want to include their spouse or significant other as an owner of their business. This makes sense if the other person is materially involved in the business. In many cases, however, it is a matter of loyalty to their spouse. They share all aspects of their lives and file a joint tax return, so it makes sense that they want their spouse to have ownership of the business.

As a business advisor, my role is to assist business owners in making well-informed decisions about their business, including ownership.  We often delve into the advantages and disadvantages of joint ownership with a spouse who may not be actively involved in the business operations.  This decision is typically influenced by the tax implications of the required tax return.

Schedule C is the appropriate tax return if the LLC has only one owner. It is a simple, two-page form that can be completed in a short period of time.  The business income is determined and is transferred to the 1040.   On the other hand, a partnership LLC must file IRS Form 1065 to document the revenues, expenses, and profits generated by the business.  In most states, ownership of an LLC by both members of a married couple is viewed as a partnership and requires filing the partnership tax return. Form 1065 spans 6 pages and requires details about potential foreign ownership, partners’ distributive share of income, a balance sheet, and more.  After completing Form 1065 and determining the business’s profits, the profits need to be divided between the partners, who are spouses in this case. Each partner must fill out a Schedule K-1 to record their portion of the profits. If the couple is filing a joint return, the profits are combined and entered on their Form 1040.

A quick check of prices charged by accountants to complete these tax forms yielded these average charges:

Schedule C  $192, at an average fee of $150 per hour

Form 1065   $733, at an average fee of $177 per hour Once I demonstrate the additional work and expense involved in making the uninvolved spouse an owner of the business, it becomes easy to decide to have a single owner.

For answers to other questions about starting a small business, please check back regularly for new blog posts and see by recent past blog posts. Also, please consider getting free business assistance from your local Small Business Development Center.

How an SBDC Consultant Can Help You

When my husband and I decided to purchase a pizza franchise, we had little knowledge about the Small Business Development Center (SBDC) program and its free assistance. When I later became an SBDC consultant, I realized how much we could have benefited from meeting with an SBDC advisor during the planning stage of our small business venture.

If you are contemplating launching a small business, consider seeking free and confidential consulting services from your local Small Business Development Center (SBDC). They can provide invaluable assistance and support tailored to your specific needs.

Business Ownership Considerations

An SBDC consultant can assist you in understanding the demands, risks, and rewards of owning your own business. It is crucial to consider how running your business will impact your family and lifestyle. For example, restaurant owners should be prepared to be present during the busiest periods, which typically occur in the evenings and on weekends. Similarly, accountants should expect to work long hours from January to mid-April. In addition to being directly involved in their businesses, business owners must also oversee employees, manage finances, handle inventory, create work schedules, promote their business, and handle numerous other responsibilities. The hours can be long and may infringe on personal and family time.

Realistic Business Loan Preparation

Just like many of our clients, Steve and I were unaware of the differences between a business loan and a personal loan. We prepared for it similarly to a personal loan but added a business plan. We should have realized that lenders needed more assurances beyond a good credit score and the ability to repay the loan. We had to convince the lender that (1) there was a demand for our products and services, (2) we knew our target clients and how to reach them, and (3) we could generate enough sales to comfortably make the loan payments. The SBDC consultant would have coached us on those 3 points and assisted us in creating 24 months of cash flow projections and validating our revenue projections.

Bank Selection

We chose a bank to apply for a loan because it was the bank used by our franchise corporation, one of the country’s largest national banks. However, we didn’t understand that each region operated independently. The bankers we spoke with knew nothing about our franchise and didn’t seem interested in a loan for a “small” business like ours. The whole process was frustrating, and in the end, the denial letter wasn’t even for our business. We should have applied to a local or regional bank. Even then, it would have been difficult to find a bank willing to lend to a start-up restaurant on our own. Today, after being a consultant for 17 years, I know how to direct clients to the banks most likely to assist them.

Research

Business planning includes defining your target customer and researching whether your local demographics include your target customer group. It also involves research into the industry you will enter. Is the industry growing? What are the trends? What are the primary products and services in your industry? You also need to know who your competitors are. Your local SBDC can provide industry reports and request local research from the national research center.

Business Plan Development and Cash Flow Forecast

Your SBDC consultant can assist you in developing your business plan, reviewing your draft, and providing feedback. Your plan will encompass an introduction to your company and ownership, a description of your products and services, an analysis of your competitors’ strengths and weaknesses, and details on how you will market your company to attract your target customers. Additionally, an SBDC consultant can help you prepare your 24-month cash flow forecast. The research they provide can aid you in writing your business plan and in estimating projected revenues.

When you decide to embark on the journey of starting your own business, it’s important to remember that you don’t have to navigate this path by yourself. Make sure to tap into the valuable resources your local small business development center provides to get the support and guidance you need.