Difference Between Partnership & Sole Proprietorship

By Cindy Hill

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.

Tax Filings

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.

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Management

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.

Ownership

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.

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Comparison: LP and LLP

References

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S Corporation Structure

An S corporation is a tax designation that a business must apply for with the Internal Revenue Service. Used for small businesses, the benefit of the S corporate designation is that it allows the business to be taxed as a partnership. To apply for S corporate status, the business must submit a completed Form 2553 within 2 months and 15 days after the beginning of the first tax year that it wants to be treated as an S corporation.

South Carolina LLP Laws

South Carolina law regulates how a Limited Liability Partnership, or LLP, may form, operate, and ultimately dissolve. Unlike limited partnerships or general partnerships where one or more partners are personally liable for the debts of the business, an LLP limits liability for all partners. Each partner may participate in the management of the business, and receive a portion of the profits.

How to Change Ownership From a Proprietorship to a Partnership

If you are a sole proprietor, it is easy to form a partnership -- simply agree with at least one other person to do business together and share profits and losses. Your company will automatically be treated as a general partnership for legal purposes, even with nothing more than a handshake to seal the agreement. The resulting partnership could face significant legal liability, however, unless you resolve certain matters and create a written partnership agreement.

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