Differences Between Sole Proprietorship, Partnership & Corporation

By Jeffry Olson, J.D.

Differences Between Sole Proprietorship, Partnership & Corporation

By Jeffry Olson, J.D.

When starting a business, one of the first decisions an owner must make is what structure to use. A sole proprietorship is where the single owner operates the business. A partnership is similar, however, it is owned by two or more individuals. A corporation is a legal entity separate from the owners of the business. There are a number of factors to consider before deciding which route to take.

Businessman with arms crossed

How a Sole Proprietorship Works

A sole proprietorship is one of the easiest forms of business to start partially because it requires no filing of documents. If a single person starts a business and takes no further steps, it is a sole proprietorship. All income or losses are taxed to the owner as personal income. This flow-through taxation is a significant benefit for many owners. However, a sole proprietorship also provides no liability protection for the owner. The owner is personally responsible for all liabilities, placing his or her personal assets at risk.

A sole proprietorship must meet any licensing requirements associated with their type of business. Further, if a sole proprietorship wishes to operate under a fictitious name, also called a doing business as (DBA) or assumed name, the owner must complete any filing required by her jurisdiction.

How a Partnership Works

A partnership is a business owned by two or more people that requires no filing of documents. Each partner participates equally in the operation unless a formal partnership agreement says otherwise. The partners may also agree in writing to an unequal share of the profits or losses from the partnership if this is the case.

Similar to a sole proprietorship, partners report their share of any losses or profits on their personal income taxes. Partnerships also provide no liability protection for owners. Each partner is personally responsible for all liabilities, placing the partners' personal assets at risk.

In addition to complying with appropriate licensing requirements, a partnership operating under a fictitious name must file to establish a DBA or assumed name with the appropriate jurisdiction.

How a Corporation Works

Unlike a sole proprietorship or partnership, forming a corporation requires filing articles of incorporation with the state where the corporation will conduct business. A corporation is a legal entity that is separate from its owners, called shareholders. The shareholders do not necessarily operate the business. Instead, shareholders elect a board of directors who then elects the corporation's officers to operate the business. Depending on the corporation, shareholders may also serve as officers.

As a separate legal entity, corporations pay taxes on profits. After taxes, profits are distributed as dividends to shareholders who then pay personal income tax on the dividends. Because they are separate legal entities, corporations provide liability protection. The personal assets of shareholders are not subject to the liabilities of the corporation.

If a corporation meets Internal Revenue Service requirements, it may select alternative tax treatment. S corporation status allows a corporation to pass profits or losses directly to shareholders, avoiding taxation at the corporate level. S corporations provide shareholders with the same limited liability status of corporations.

Sole proprietorships, partnerships, and corporations each provide distinct advantages and disadvantages depending on the number of owners, type of taxation, and liability you desire for your business. While determining what structure would work best for you, also factor in your state's laws to see if there may be any pros and cons that could further help you with your decision.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.