Q: Can a Sole Proprietorship be owned by husband and wife?
A: If a business is owned jointly by a husband and wife, it cannot claim to be a sole proprietorship but rather is considered a general partnership unless it is specifically organized as a Subchapter S corporation or LLC. A wife may work as an employee in a sole proprietorship, and take a salary, so long as the business is owned by the husband and not owned jointly by both husband and wife. And vice versa, a husband may work as an employee in a sole proprietorship so long as the business is owned only by the wife and not jointly by the two.
Q: I often see distributions exceeding basis because real estate assets are shown at cost on tax return, but it doesn't take into account fair market value.
A: For the owner of a Subchapter S corporation, "basis" is the sum of an owner's capital investment plus earnings retained in the business – accrual net worth – plus owner loans to the business, which are considered quasi-equity. For a partner in a partnership, "basis" is the partner's accrual net worth in the business plus the share of liabilities for which he or she is responsible.
Based on these definitions, "basis" does not include the market value of real estate assets. The market value of such assets plays no role in determining "basis" and, therefore, in determining if distributions exceed "bass" for an owner or a partner.
Q: Can you repeat the statement about what is considered non-cash?
A: Pass-through entities must pass the amount of taxable business income to their owners or partners who are responsible for paying the income tax obligation on this taxable business income. The term "non-cash" used in this session refers to the fact that the taxable business income passed through to owners and partners is non-cash to these owners or partners – a dollar amount that must be reported on the owners’ or partners’ personal Form 1040. The cash from taxable revenue, expenses, and profit or loss stays with the company.
Q: Isn't it advantageous to reduce the net income?
A: It is advantageous to the taxpayer - the owners or partners - to reduce taxable business income, which is one fundamental reason why it is inappropriate to use business tax returns to compute performance ratios and cash flow statements. They tend to cast the business in a far less attractive light than performance ratios and cash flow statements based on accrual financial.
Q: What is the taxable impact if Distributions exceed Basis?
A: If distributions exceed one’s "basis" in the company, the excess distribution is taxed at the long-term capital gains rate then in effect.
Q: Normally sole proprietorships are usually husband and wife or an individual. Can it also be two brothers? For example, the name of the business could be: "Brother A with last name and Brother B with same last name DBA Brother A with last name and Brother B with same last name Property."
A: Only a single individual can own a sole proprietorship, regardless of the company name. If two brothers jointly owned a company, it would be considered a general partnership by the IRS unless the two owners organized it as a Subchapter S corporation or LLC. Therefore, one brother would need to give up his ownership share if the company were to be operated as a sole proprietorship.
Course overview: Business Income Tax Returns