Pros and Cons of the three Business Types


Earlier, I made a post based on the things that I’ve learned from Kiyosaki’s teachings on the three basic business entities: Sole Proprietorship, Partnership, and Corporation.

Kiyosaki says that most people earn money, pay taxes through withholding, and spend what little is left over. The rich do it differently. They earn money, spend it, and then pay taxes. The government gets less that way, and it’s legal.

Employees of corporations:
Earn       →     pay taxes      →      spend

The rich who have corporations:
Earn       →      spend       →      pay taxes

What is the secret of the rich? They take advantage of the tax loopholes that allow individuals to choose different entities for their businesses. Loopholes, though they may have a negative connotation for some, are intended to help businesses grow and prosper. The tax law allows a corporation, for example, to earn, spend everything it can on legitimate business expenses, and then be taxed only on what remains. How can you get in on this secret? First by learning what business entities are available to you and what the advantages and disadvantages are of each. These entities include the sole proprietorship, the partnership, and the corporation.

SOLE PROPRIETORSHIP:

This is the oldest and simplest form of business. The owner and the business are one and the same, enjoying all the benefits but assuming all the debts and tax responsibilities. Only one person is required to form a sole proprietorship, and since there is legally no difference between the owner and the business, all income generated by the business is regarded as personal income. The owner reports all business income and losses on his income tax return and is allowed to deduct business expenses. The owner is also personally liable for the business and can be sued by an unhappy customer or unpaid creditor. If business assets cannot satisfy such a claim, the owner’s house, car, and other personal assets are vulnerable.

Sole Proprietorship Pros and Cons:

PROS:

  • Owner is complete control
  • Flexible decision making
  • Business expenses deductible
  • Owner earns all profits
  • Easy and inexpensive to set up

CONS:

  • Owner completely liable for debts and suits
  • Business terminates with owner’s death
  • Tax rate may be higher than other entities

PARTNERSHIP:

A partnership is two or more people co-owning a business for profit. The partners agree to establish and run the business, sharing in profits, assuming responsibility for all losses and liabilities, and paying all taxes, which are paid at the individual rate. There are two types of partnerships: general and limited.

In a general partnership, the partners have full rights to control all the day-to-day affairs of the business. They also share all the liabilities for the partnership’s debts or obligations. If the partnership’s assets are insufficient to meet its obligations to creditors, or if a third party is damaged or injured, then each partner’s personal assets can be taken to satisfy the debt.

General Partnership Pros and Cons:

PROS:

  • Combined assets and expertise
  • Flexible decision making
  • Partners, not partnership, taxed at the individual level
  • Business expenses deductible
  • Ease of formation

CONS:

  • Partnership terminates on death or withdrawal of any partner
  • Partners totally liable
  • Each partner can enter into other business agreements, so control is difficult
  • Each partner is individually liable for agreements made by any partner

A limited partnership has both general partners, who run the daily business and make all the decisions, and limited or silent partners, who generally put up the money in hopes of profit. Limited partners have limited financial liability, meaning that if a creditor or an injured party sues, limited partners can’t be held responsible for any more than the amount they originally invested. When it comes to taxes, general partners and limited partners are treated the same way. Any profits from the business go directly to them, that is, they are “passed through” to all the partners, who report their share of the partnership net income on their individual tax returns.

Limited Partnership Pros and Cons:

PROS:

  • Limited partners are not personally liable for the partnership’s debts and obligations
  • Partnership does not dissolve with death of limited partner
  • Number of partners/owners unlimited

CONS:

  • Transfer of interest usually requires general partner approval
  • Complete and separate paperwork filings
  • Limited partners have little, if any, control over daily operations

CORPORATION:

Most people think of a corporation as a business in a big building with lots of employees. A corporation is really nothing more than a way of doing business. It is a legal entity regarded as separate from the owner, one that offers distinct tax advantages as well as liability protection from creditors and others who might sue. The owner controls the corporation and is a shareholder, possibly the only shareholder. As owner and shareholder, the owner is the boss.

The owner controls what happens in the corporation, but because the corporation is a separate entity, the owner doesn’t own any of the corporation’s assets and therefore doesn’t have to assume any of the corporation’s debts.

Rich Dad Tip:

“Utilizing the corporation is one of the secrets of the rich: Own nothing, but control everything.”

Pros and Cons of Corporation:

PROS:

  • Limited liability in case of lawsuit
  • Shareholders risk only their investment
  • Easy to sell small portions of stocks to raise capital
  • Tax rate may be lower
  • Corporation can elect different year-ends than shareholders which is helpful for tax planning

CONS:

  • State laws can limit operating flexibility
  • Corporations must comply with recordkeeping and other government regulations
  • Double taxation occurs when dividends are paid to shareholders (on shareholder’s individual account and corporation’s account)

THE SECRET OF THE RICH IS IN THE CORPORATION!

The secret of the rich lies in corporatons. This secret has been around ever since the days of sailing ships, when the rich created the corporation as a vehicle to limit their risk. The rich would put their money into a corporation to finance a voyage. If the ship was lost the crew lost their lives, but the loss to the rich would be limited to the money they invested for that particular voyage. Corporations can protect assets and serve as vehicles for the creation of new assets.

Source: Robert Kiyosaki’s Coaching Program

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Tyrone is a passionate financial literacy advocate. He started this blog on November 2008 when he watched The Secret which talked about Law of Attraction because he wanted to become a millionaire and wanted to know how a millionaire acts. At the age of 26, he achieved his first million. To find out more about him, click here or follow him at Instagram

6 responses on “Pros and Cons of the three Business Types

  1. Kiyosaki should be an inspiration to all. Knowing which entity suits your company best is a task in its own.

    I have fallen into the business software industry by chance (I am a graduate of Economics) and as a result have become highly interested in the online world. We are so lucky in this day and age that we can literally start a business without having to invest hardly any capital.

    I will make sure to keep this article in mind once I get to the crossroad where I will need to decide.

  2. Yet another excellent topic. Many peopel who work from home or that have home based businesses don’t even think about this question, but they…we have even more opportunities than businesses that operate outside the home, to benefit from setting up our businesses in the right structure… you can (depending on your structure and state laws) potentially write off portions of your mortgage, car payments, even allowances to your kids!

    It’s great!

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