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Sole proprietorships vs partnerships

Are you an entrepreneur who is preparing to form a new business?

If so, it is essential that your company has the right foundation in place.

A business needs a reliable structure to thrive. You may be considering setting up your business as either a sole proprietorship or a partnership. At Padgett, we provide a wide range of tax, accounting, and business advisory services to small businesses. In this article, our small business tax advisor provides an overview of the key things to know about sole proprietorships, partnerships, and the pros and cons of these two business structures.

An Overview of

Sole proprietorships

The Internal Revenue Service (IRS) defines a sole proprietorship as “someone who owns an unincorporated business by himself or herself.” In other words, a person who operates their own business without any specific form is a sole proprietor. If the business formed an LLC, then a sole proprietorship is one that has only one member, which has not elected to be treated as an S-Corp, or a C-Corp. There are benefits and drawbacks to operating a business as a sole proprietorship, including:

  • Pros of sole proprietorships: To start, sole proprietorships are relatively easy and inexpensive to set up, as there are few legal requirements to follow. Next, the sole proprietor always retains full control over the company. Finally, a sole proprietorship reports all the activity for the business on Schedule C of their personal 1040 return, so no additional tax return is required.
  • Cons of sole proprietorships: While there are benefits to a sole proprietorship, it is not the right business entity for every situation. One major drawback of a sole proprietorship is that the business structure offers no liability protection, even if the sole proprietorship is an LLC. The owner of the business can be held personally liable for the full extent of the sole proprietorship’s debts. Another disadvantage is that a sole proprietorship has no real ability to raise outside capital. Finally, the structure of the business fundamentally limits the potential to expand.

An Overview of

Partnerships

As explained by Investopedia, “a partnership is a formal arrangement by two or more parties to manage and operate a business and share its profits.” An LLC with more than one member is taxed as a partnership, unless it has elected to be taxed as a C-Corp or S-Corp. Depending on your circumstances it may or may not be the right structure for your business. Here are some of the pros and cons of forming a partnership for your business:

  • Pros of partnerships: There are several potential advantages to organizing a business as a partnership. A major pro of a partnership is the ease of formation. A partnership can have relatively low start-up costs and is fairly straightforward to form. Another advantage is that a partnership is a pass-through entity. There can be tax advantages to forming a partnership. Another benefit of a partnership is that it is a flexible entity that allows for shared management responsibilities.
  • Cons of partnerships: There are also disadvantages to organizing a business as a partnership. A major disadvantage is the lack of personal liability protection. Some partnerships offer no liability protection at all (GPs). Partners may also have to share liability for each other. Operating as an LLC partnership may provide liability protection for a partnership. Another downside is that partnerships are difficult to transfer. Finally, it can be difficult to access outside capital with partnerships.

What are the Key Differences

What are the key differences between sole proprietorships vs partnerships?

There are some important similarities between sole proprietorships and partnerships. Both types of businesses are pass-through entities for tax purposes, and both offer little to no liability protection unless they are also an LLC. At the same time, there are also key differences between sole proprietorships and partnerships, including:

  • Ownership: A sole proprietorship is owned and operated by a single individual, while a partnership involves two or more individuals who own and operate the business together.
  • Management: In a sole proprietorship, the owner has sole decision-making authority and is solely responsible for managing the business. In a partnership, the partners share management responsibilities and make decisions together.
  • Liability: As a sole proprietor, you are personally liable for all debts and obligations of the business. In a partnership, liability can be more complicated. It depends on the structure of the business partnership.
  • Continuity: A sole proprietorship is dissolved upon the death or departure of the owner, while a partnership may continue to operate if the remaining partners agree to do so.

Sole Proprietorships and Partnerships

FAQs

Both sole proprietorships and partnerships are pass-through tax entities. A pass-through tax entity is a business structure in which the business itself is not taxed on its income. Instead, the owners of the business are taxed on their share of the business's income on their personal tax returns. With a sole proprietorship, the owner is personally taxed on all of the business's profits. With a partnership, each partner is taxed on their share of the partnership's profits.

Yes, there are actually several different types of business partnerships. Most states recognize the following types of business partnerships:

  • General Partnership (GP): In a general partnership, all partners are personally liable for the debts and obligations of the partnership. Each partner's personal assets, such as their homes and savings, are at risk if the partnership is sued or incurs debt.
  • Limited Partnership (LP): In a limited partnership, there are both general partners and limited partners. The general partners are responsible for managing the partnership and are personally liable for its debts, while the limited partners are only liable to the extent of their investments in the partnership.
  • Limited Liability Partnership (LLP): An LLP is a type of partnership in which the partners have some form of liability protection. In effect, this means that the partners are not personally liable for the debts and obligations of the partnership. LLPs are often used by professionals, such as lawyers or accountants, who want to protect their personal assets.

Some jurisdictions also recognize other types of business partnerships as well, with the most common being the limited liability limited partnership (LLLP).

Sole proprietorships and partnerships are common business structures for small businesses and startups. They are relatively easy and inexpensive to set up, and they offer a great deal of flexibility in terms of management and ownership. They are used in a number of different industries, including professional services, freelance businesses, and home-based businesses. Whether a sole proprietorship, a partnership, or another business entity is most beneficial for your situation depends on many different factors, including the need for liability protection and growth potential.

Get help from our small business tax professional today

At Padgett, we are proud to be the leaders in tax guidance for small businesses, including sole proprietors and partnerships. Our firm has more than five decades of successful experience. If you have any questions about forming a sole proprietorship or a partnership, we are ready to help. Contact us today to set up a confidential initial appointment with a top small business tax advisor. We provide nationwide tax services to sole proprietors and partnerships.

We encourage you to contact us with any questions.

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