Put Your Small Business Financial Knowledge to the Test

Correct Answers

1. a) Sole proprietorship.

A sole proprietorship is the most common business structure. The IRS received about 6.8 million corporate tax returns, 4.5 million partnership tax returns and 31 million nonfarm sole proprietor tax returns (Schedule C), according to the latest reported data from the Statistics of Income Bulletin (fiscal year 2022).

A sole proprietorship is also the simplest form of business ownership, because you aren't required to take any formal action to form it, as long as you're the only owner. But like any business, a sole proprietorship needs to obtain the necessary licenses and permits. Sole proprietorships that operate under a name different from the owner's most likely will have to file a "doing business as" name that another business hasn't already claimed.

There's no distinction between a sole proprietorship and its owner. The owner is entitled to all profits and is responsible for all business debts, losses and liabilities. This lack of separation has a downside: The owner has unlimited personal liability that extends to liabilities incurred because of business or employee actions. Sole proprietors may also face challenges when raising capital to grow their businesses.

2. d) All of the above.

Many private businesses elect to operate as S corporations, but not every business is eligible. To make the switch, your business must meet all the requirements listed above. Additionally, it must have only allowable shareholders, including individuals and certain trusts and estates.

Partnerships, corporations or nonresident aliens can't own shares in an S corporation. In addition, S corporations can't be ineligible corporations, including certain financial institutions, insurance companies and domestic international sales corporations. All shareholders must consent to the S corporation election by signing an IRS form.

3. a) The business sets the worker's schedule, trains the worker, and requires specific procedures and reporting.

The U.S. Tax Court considers various factors when deciding whether a worker should be classified as an independent contractor or employee for federal employment tax purposes:

• Degree of control,
• Investment in equipment and facilities,
• Whether a worker has an opportunity for profit or loss,
• Whether the worker can be discharged,
• Whether the work is related to the employer's core business,
• Permanency of the relationship between the employer and worker, and
• The relationship that the employer and worker believed they were creating.

However, some factors tend to carry more weight than others. Tax Court precedent emphasizes the right to direct and control how work is done (not just the result). A written contract helps, but actual day-to-day control carries more weight than labels.

4. c) The penalty for individuals was eliminated, but penalties for applicable large employers remain in effect.

The Tax Cuts and Jobs Act eliminated the individual mandate penalty beginning in 2019, which led many business owners to assume that all ACA penalties were repealed. That's not the case. Under existing law, ACA compliance remains an important consideration as your business grows.

The employer shared responsibility provisions of the ACA still apply to applicable large employers — generally those with 50 or more full-time equivalent employees. These employers may face penalties if they fail to offer affordable, minimum-value health coverage to full-time employees and their dependents. These penalties can materially affect payroll budgeting and growth decisions.

5. e) All of the above.

A highly profitable calendar-year C corporation must make quarterly estimated tax payments throughout the year — not just a single payment with the annual return. The IRS generally requires a corporation to make regular installment payments if management expects its estimated tax for the year to be $500 or more. Installment payments are due by the 15th day of the 4th, 6th, 9th and 12th months of the corporation's tax year.

For C corporations with a calendar year end, installment payments are due on April 15, June 15, September 15 and December 15. Failing to make timely estimated payments can result in underpayment penalties, even if the corporation ultimately pays its full tax liability when filing Form 1120. Profitable C corporations need proactive cash-flow planning to ensure funds are available when each installment comes due.

Important: Individuals who report income from sole proprietorships and pass-through entities (such as partnerships, limited liability companies and S corporations) follow a different schedule for making quarterly estimated payments.

6. c) Maybe.

If the forms of business collateral are equal to 100% of the loan, as a borrower, an owner won't have to pledge personal assets to obtain an SBA-guaranteed loan. But principal borrowers often need to pledge personal assets, such as real estate and investment accounts.

Typically, approval for an SBA-guaranteed loan isn't denied solely due to a lack of collateral. The loan may be approved based on other qualifying credit factors, such as the experience level of management or the company's credit rating.

7. c) Net income = sales – cost of sales.

Sales minus cost of sales equals gross profit, not net income. To arrive at net income, you must also adjust for selling, general and administrative expenses; discontinued operations; income taxes; and nonoperating revenues, expenses, gains and losses.

8. a) True.

Under current GAAP, the reporting requirements for private business combinations are less complex than for public entities. Private companies may elect to amortize goodwill and certain other intangible assets acquired in business combinations over 10 years (or less) instead of testing them annually for impairment. Under GAAP, private companies can also combine noncompetition agreements and certain customer-related intangibles with goodwill.

9. b) False.

Under current GAAP, operating leases with terms of 12 months or longer are no longer "off-balance-sheet." Businesses must recognize both a right-of-use asset and a corresponding lease liability on the balance sheet for long-term leases. Lease expense continues to appear on the income statement, but the obligation itself is now visible on the balance sheet, too.

This change matters because leases can significantly affect key financial metrics, including leverage ratios, working capital and debt covenants. Business owners who focus only on the income statement may underestimate how lease commitments affect their company's overall financial position and borrowing capacity.

10. b) Cash inflows don't always arrive in time to cover cash outflows.

Profitability and cash flow are related, but not the same. A business can report strong profits while still struggling to pay bills if cash is tied up in accounts receivable, inventory or long-term projects, or if debt payments come due before customer payments are collected.

This timing mismatch is one of the most common reasons profitable small businesses experience financial stress. Monitoring cash flow helps owners anticipate shortfalls, manage growth responsibly and avoid surprises that can upend day-to-day operations.

Building Financial Confidence

Whether you're a seasoned small business owner or a new one — or you plan to open a business in 2026 — running a successful operation requires a broad mastery of tax, financial reporting, financing and other strategic issues. No small business owner starts out knowing everything about finance and accounting, and that's OK. What matters is recognizing where financial insight can improve decision-making and knowing when to ask for help. By building your financial literacy and working with trusted advisors, you can gain confidence, reduce surprises, and focus more energy on running and growing your business.