Sole proprietor or Partnership? Do both partners have to pay self-employment tax, double the sole p. rate?

Question

My live-in son would like to start a small business. I would help him, but really don't need the money and would work for free. I realize that as a sole proprietor he would owe self-employment taxes. If we would decide to become partners to make it easier for me to help him with business contacts, would I have to pay self-employment taxes too, making the tax owed on the business double? How would we file income taxes - on a joint business return or on our individual tax returns. I currently file jointly with my husband. We don't expect much of a profit initially, so a double self-employment tax between us would really eat into profits.

Answer 1

Tax isn't double for partnership versus a sole proprietorship.

SE tax is 15.3% of 92.35% of net self-employment income.

If business made profit of $50,000 taxes would be as follows:

Sole proprietorhip $50,000 x 92.35% x 15.3% = $7,065

Partnership $50,000 x 92.35% x 15.3% = $7,065

Same amount of taxes. If it's a 50/50 partnership each partner would have half the income, $25,000, and pay se tax on that half, which would be $3,532.

For a partnership, you would file a 1065 return, and you and your son would get a K-1 for your share of the business activity for the year, and if the partnership was 50/50 each of you would have a K-1 reflecting your half ownership.

The only advantage that I can see for having it be a sole proprietorship is if the business hits the social security tax limit, which is $97,500 for 2007. If the net SE earnings reach that amount then the SE tax rate changes from 15.3% to 2.9% for the income above $97,500.
So if your son made a net profit of $100,000 he would pay se tax at 15.3% for the first $97,500 of income and 2.9 for the amount above it. For a partnership you'd have to make double the $97,500 for the se tax rate to decrease, since the income would be split between 2 people.

Answer 2

From an employee's paycheck social security and medicare taxes are withheld at 7.65%, and the employer pays (over and above the employee's salary) another 7.65% from their fund.

For your self employment income from sole proprietor, you are both an employee and an employer. So you pay 15.3% employment taxes.

Income from your sole proprietorship firm/company is your own income. You complete form C for business income and attach it to your 1040. You firm/company does not file any separate return.

When you have a partnership, the partnership files Form 1065 and does not pay any taxes. The profit of a partnership is divided among the partners. Partners must include this profit in their own income and on this income pay 15.3% employment taxes.

Answer 3

Taxes can really eat into profit ..I know!! (unless you are making money pretty well right off the bat!) I had a Music Studio for 20 years..and it seemed I saved all year to pay the taxes!! I LOVED the work..but the money thing was a hassle.

Have you ever considered an on-line business for your son in Real Estate? I have been working this for awhile and it is great. You can work it from anywhere in the U.S. with little overhead. Internet connection..cell phone and computer is about it with a little tuition and start-up cost. It is already there and all lined out to work for us..and it is a part of the Better Business Bureau on and off line.

http://www.freedomforeclosure.com/smahon

Answer 4

The end result for taxes would be the same. If you have a partnership you would need to file a IRS Form1065 tax return. If you are paying to have your taxes done it will cost about twice the cost of filing as a Sole Proprietorship. People starting new enterprises really need to get some professional advise before they decide what form of ownership they will use on a business venture.

Answer 5

Partnerships and Sole Proprietorships are taxed the same. The net profits to the owners/partners are subject to income tax and self-employment tax.

One difference: A partnership needs to file a tax return itself (Form 1065). It doesn't pay taxes itself but it needs to file the return.

Answer 6

First, with a partnership you must always have at least one general partner. Here, we presume it will be your son, since he is running the biz. You then could be either a general ptr or a limited ptr. As Gen Ptrs, both his and your liability is unlimited and you will each pay S/E tax on your respective shares of guaranteed payments and profits. If you choose to be a limited partner, your liability is limited to your $ amount invested into the P'ship. Then only that portion of your income deriving from your active participation ( usually guaranteed payments) in the business is subject to SE tax.all of your income, including your share of profit is subject to income tax.

Here is a simple explantion of P'ship taxation. The P'ship maintains books and records of all transaction during the year. These records are used to prepare a partnership tax return (Form 1065). The profit of the P'ship and all other types of income, and contributions from & distributions to the partners are reported on Schedule K, and each partner's pro-rata share is reported on form K-1 (1065). This latter form is then used by the partners to prepare their own form 1040.

Answer 7

You would only pay taxes on your share of the profit. Your profit split can be anything that you and your son agree on. In other words, your ownership percentage and your profit percentage can be different. If you want to have more of a part-time advisory role, you can for example be a 50% owner and only take a 25% profit share. You only pay taxes on your share of the profit.

You should contact an accountant now if you plan to go ahead with this, and since this is the off-season for tax preparers, he or she will have more time to patiently explain all of this to you in detail.

If you are truly going to be working "for free", then you could simply agree to a very low profit split. Any profits accrueing to you would be subject to the SE tax though.

Answer 8

Why not just loan him the money for his business. Have loan documents drawn up with a market value interest rate. That way, there are no tax ramifications to you on business profits. You will however pay income taxes on the interest that he pays you for the loan.

An LLC could be created if you want to be an equity owner as additional collateral for the money you are advancing. With proper planning, it can be set up in such a way that you will not be subject to self-employment taxes on any income. You will be subject to income taxes though.

I strongly suggest that you obtain professional assistance before you finalize the arrangement.

Answer 9

Partners report their profits on Form 1040, Schedule SE just the same as income from a sole proprietorship