Sole proprietorships and partnerships are common business entities that are easy for owners to establish and manage. The primary distinction between the two is the number of owners. You are the sole proprietor of a sole proprietorship (in some states, your spouse may be a co-owner).
When you form a partnership, you must have at least one co-owner. When you own a business with someone else, you have to deal with additional issues, such as resolving conflicts among the owners and allocating responsibilities, profits, and losses.
What is a Sole Proprietorship?
You have a sole proprietorship as soon as you start doing business on your own, whether you accept money to mow your neighbor’s yard or sell your homemade jewellery online. In some states, if you co-own a business with your spouse, it is still considered a sole proprietorship.
To form some business entities, such as corporations and LLCs, you must file formation documents with the state (such as Articles of Organization). In contrast, you form a sole proprietorship as soon as you accept payment for your goods or services and do not file any formation paperwork.
Although you are the sole owner of a sole proprietorship, you are not required to work alone. You can run your business with the help of employees, freelancers, and consultants. However, you are the one in charge of making business decisions, and all profits and losses will be yours.
What is a Partnership?
A partnership, also known as a general partnership, is formed when you and another person begin doing business with the intention of profiting. The collaboration could begin with the signing of a contract to work together, or it could begin with a conversation and a handshake. You may have an unlimited number of partners, who may be individuals or businesses. A partnership, like a sole proprietorship, is formed without the filing of any paperwork with the state.
The advantage of forming a partnership over forming a sole proprietorship is that you will share responsibilities, resources, and losses. On the other hand, your profits are split, and you may have disagreements about how to run the business. Creating a partnership agreement is one way to minimize conflict.
The law does not require partnerships to have a partnership agreement, but you may benefit from drafting one to clarify each partner’s expectations and roles in the business. You can specify in the agreement how the partners will share responsibilities, profits, and losses. You can specify when and how the partnership can end, as well as whether partners can sell their stake in the company to third parties.
Business Licensing and Names
When it comes to business licenses and name registrations, sole proprietorships and partnerships have the same responsibilities. Even if you do not file formation paperwork with the state to form a sole proprietorship or a partnership, you are still required to obtain other business licenses or permits. Some towns and counties require all businesses to obtain a local license or permit. Depending on the goods or services you provide, you may require specialized licenses from government agencies, such as a food handler’s permit or a license to sell cannabis.
You must file for a Doing Business As (DBA) or a Fictitious Business Name if you want to do business under a name other than your own or your partner’s. For more information, contact your Secretary of State.
Personal Liability for Business Debt
Neither sole proprietorships nor partnerships shield the owners from the business’s obligations. Creditors can seize your personal assets, such as your home, bank account, and car, to pay off the business’s debts. The law makes no distinction between you and your company. When a company owns property, so do you. Suing a partnership or a sole proprietorship is the same thing as suing the owners.
When you form a partnership, you may be personally liable for anything your partner does while running the business. You will, however, not be held liable for all of your partner’s actions. For example, if your partner caused a car accident while you were on vacation, your personal assets would not be at risk to pay for the accident’s damage. However, if your company provides a delivery service and your partner crashes the company truck while making a delivery to a customer, you may be held personally liable.
Sole Proprietorship and Partnership Taxes
Both types of businesses are “pass-through entities,” which means they do not pay corporate tax. Instead, income “passes through” the entity, and the owners pay taxes on their individual tax returns. Owners of both entities pay self-employment tax on their portion of the income, but they can take advantage of the 20% pass-through deduction to reduce their personal tax burden.
While the IRS taxes each entity in the same way, the way the owners of each entity report their income differs:
- Sole proprietors report their business profits and losses on Schedule C of their personal tax returns. They only file one return.
- Partnership owners are required to file two returns: They file Form 1065, which is a separate informational tax return. Because the partnership has allocated a portion of the partnership’s profits and losses to each partner, each partner reports their portion on Schedule E of their personal tax returns.