248 Planning and Forecasting
expected that the managers of an LLC will be held to the same fiduciary stan-
dards as corporate directors and general partners of limited partnerships, re-
sulting in their potential personal liability to the members.
TAXATION
Entrepreneurs make a remarkable number of significant business decisions
without first taking into account the tax consequences. Tax consequences
should almost never be allowed to force an entrepreneur to take actions he or
she other wise would not have considered. But often tax considerations lead one
to do what one wants in a different manner and to reap substantial savings as a
consequence. Such is often the case in the organization of a business. The fol-
lowing discussion will be confined to the federal income tax, the tax with the
largest and most direct effect upon organizational issues. Each entrepreneur
would be well advised to consult a tax adviser regarding this tax as well as state
income, estate, payroll, and other taxes to find out how they might impact a
specif ic business.
Sole Proprietorships
Not surprisingly given the factors already discussed, a sole proprietorship is
not a separate taxable entity for federal income tax purposes. The taxable in-
come and deductible expenses of the business are set forth on Schedule C
of the entrepreneur ’s Form 1040 and the net profit (loss) is carried back to
page 1, where it is added to (or subtracted from) all the taxpayer ’s other in-
come. The net effect of this is that the sole proprietor will pay tax on the in-
come from this business at his highest marginal rate, possibly as high as 39.1%
(in 2001), depending upon the amount of income received from this and other
sources (see Exhibit 8.2).
In Phil’s case, for example, if his software business netted $100,000 in
2001, that amount would be added to the substantial interest and dividend in-
come from his other investments, so that he would likely owe the IRS $39,100
on this income. If Phil’s business were run as a separate taxable corporation,
the income generated from it would be taxed at the lowest levels of the tax-rate
structure, because this corporate income would not be added to any other in-
come. The first $50,000 of income would be taxed at only 15% and the next
$25,000 at only 25% (see Exhibit 8.3).
This argument is turned on its head, however, if a business anticipates
losses in the short term. Using Phil again as an example, if his business oper-
ated at a $100,000 loss and as a separate taxable entity, the business would pay
no tax in its first year and would be able to net its early losses only against
profits in future years and only if it ever realized such profits. At best, the
value of this tax benefit is reduced by the time value of money: At worst, the
loss may never yield a tax benefit if the business never does more than break