The Advantages and Disadvantages of Sole Proprietorships, Partnerships & Corporations

by John Cromwell

    All you need to start a business is a product, a plan and customers. But if you want to maximize your business’s potential, you need to choose the correct business form for you. There is no single optimal business form; the best choice depends on the circumstances surrounding your business. You will need to balance your long-term goals with tax, regulatory and structural requirements. Each business organization operates subject to state law, so you should review the law of the state where your business will operate prior to selecting an option.

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    Sole Proprietorships

    A sole proprietorship is the easiest type of business to form. All you need to do is to start operating your business; no additional state filings are required. All income you earn from the business is reported on your personal tax return, and you will be required to pay taxes on the income you earn. The disadvantage of a sole proprietorship is that you are personally liable for all obligations and liabilities incurred by the business. If the sole proprietorship lacks the resources to meet its responsibilities, you will have to make up the difference with your personal funds.

    General Partnerships

    General partnerships are a lot like sole proprietorships except there are multiple owners of the business instead of just one person. All you need to form a partnership are multiple owners working together to make a profit by selling a good or service. Each partner must record his share of the business’s income and expenses on his personal income tax return and pay tax on it. The key disadvantage of a partnership is that the partners are liable for all business debts, so if the partnership lacks the funds to pay a debt, the partners must make up the difference.

    Corporations

    Corporations are very different from sole proprietorships and general partnerships. To form a corporation, you must file articles of incorporation with the state. Corporations are generally at a disadvantage when it comes to taxes, as well. When a corporation earns money, the corporation is taxed as a separate entity, so the business’s income is not included on the corporation owners’ tax return. However, any time the corporation distributes its earnings to its owners, they must pay taxes on what they receive. This means that any income a corporation earns is taxed twice. The chief advantage of corporations is that the owners are not liable for the business’s debts. If the corporation cannot pay its bills, the creditors generally cannot sue the corporate owners to make up the difference. Also, corporations are used if the business wants to be publicly traded.

    Additional Considerations

    While the filing requirements tied to forming a business may vary, generally the filing requirements for businesses that have employees do not. Regardless of your business form, if you have employees, the federal and state governments will require that you file paperwork for withholding taxes. Also, if your business operates in a field that requires a license, it will still need to file the appropriate paperwork to obtain that license regardless of its organizational form.

    About the Author

    John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.