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Unit 8: Tax Planning for Different Organisations

7. Lack of continuity i.e. the existence of a sole proprietorship business is dependent on the Notes
life of the proprietor and illness; death etc. of the owner brings an end to the business. The
continuity of business operation is therefore uncertain.

8.2.1 Tax Aspects of a Proprietorship

When filing an income tax return, no legal distinction exists between a person as a sole proprietor
and an individual person. The sole proprietor’s personal income tax return (Form 1040) must
include calculation of the proprietorship’s income tax as well as any income or loss that the
owner incurs from any additional entity, such as an employee, investor, or the like. The tax code
treats the sole proprietorship and the owner as one and the same: income earned by the business
is seen as income of the owner and must be reported on the owner’s IRS Form 1040. Expenses of
the business are also claimed by the owner as deductions against income on the owner’s year-end
tax return.

Another important point to remember about sole proprietorships is that sole proprietorships are
taxed on all net income; there is no way for your small business to retain earnings without you
being taxed on that money. So if you expect or want to use income from the business to grow
(i.e., you are going to reinvest the profits back into the business), you may want to consider

creating a C-corporation.

Computation of Tax Liability of the Individual
The tax liability of the Individual on its taxable income is computed in the following manner:

(i) Ascertain the ‘total income’ of the individual by aggregating incomes falling under
following four heads:-
(a) Income from House Property, whether residential or commercial, let-out or self-
occupied. However, house property used for purpose of individual’s business does
not fall under this head.

(b) Profits and Gains of Business or Profession.

(c) Capital Gains.
(d) Income from other sources including interest on securities, winnings from lotteries,
races, puzzles, etc.
(ii) To the total income so obtained, ‘current and brought forward losses’ should be adjusted
for set off in subsequent assessment years to arrive at the gross total Income. The total
income so computed is the ‘gross total income’.
(iii) From the gross total income, prescribed ‘deductions’ of the Income Tax Act, 1961 shall be
made to get the ‘net income’. Generally, all expenses incurred for business purposes are
deductible from taxable income, given that the expenses must be wholly and exclusively
incurred for business purposes and also that the expenses must be incurred/paid during
the previous year and supported by relevant papers and records. But expenses of personal
or of capital nature are not deductible. Capital expenditure is deductible only through
depreciation or as the basis of property in determining capital gains/losses. But no
deduction shall be allowed in respect of any expenditure incurred in relation to income
which does not form part of total income.

(iv) Tax liability is computed on the ‘net income’ that is chargeable to tax. It is done either on
accrual basis or on receipt basis (whichever is earlier). However if an income is taxed on
accrual basis, it shall not be taxed on receipt basis.
(v) From the tax so computed, tax rebates or tax credit are deducted.

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