The decision regarding how to structure a new business is one of the first and most important decisions a new business owner must make. Whether to share the risks and rewards of business ownership with other people as partners or maintain complete control over the business as a sole proprietor is a choice that will directly affect the management of the business and how it pays taxes.
Number of People
The number of people involved in business ownership will affect the choice of whether to form an unincorporated business as a sole proprietorship or a partnership. If only one person will own the business, the business cannot be formed as a partnership. By definition, a partnership requires the ownership interest of two or more individuals, but two people may operate a business as a sole proprietorship only if they are spouses who qualify to file a joint married tax return and are co-owners of an unincorporated business with no other owners. In such a case, the couple may elect to be treated as a qualified joint venture sole proprietorship for tax purposes.
Although neither a sole proprietorship nor a partnership are taxed as entities separate from their owners, the required tax filing paperwork is different for the two entities. The owner of a business operated as a sole proprietorship reports business income and expenses on IRS Schedule C, which becomes part of that business owner's personal Form 1040 federal income tax return. A partnership must file an annual informational return with the IRS that reports the partnership's income, expenses, profits or losses. The partnership must also provide IRS Form 1065, more commonly known as Schedule K-1, to the partners, identifying each partner's share of the partnership's proceeds for the year. Each partner then reports the profit or loss amount specified on Schedule K-1 on the Form 1040 federal income tax return as an individual.
The owner of a sole proprietorship can manage the business in any way he sees fit, within the bounds of the law. A sole proprietor's business decisions do not need the advice, consent or approval of anyone else. On the other hand, business partners must adhere to their state's partnership laws and share control of the business with co-owners. Business decisions must be made by the partners under whatever terms are established by the partnership agreement. That partnership agreement may give all partners an equal vote in business decisions or create different classes of partners with different voting rights.
A sole proprietor owns 100 percent of the business and is entitled to all of its profits, but he also must shoulder all of its losses and takes all of the risk. A sole proprietor is personally liable for debts incurred by the business. Partners in a partnership own a percentage interest of the company, receive a proportionate share of the partnership profits and share in its losses. Absent a partnership agreement that limits the risk exposure of some classes of partners, general partners are also liable for the debts and liabilities of the partnership.