LLP or Sole Proprietor?

By Cindy Hill

Choosing between operating a small business as a sole proprietorship or as a limited liability partnership, or LLP, requires determining who will have an ownership stake in the business. Other than a married couple meeting IRS rules for a qualified joint venture, any two or more people owning a business together cannot operate as a sole proprietorship. An LLP is an efficient way for two or more people to own a small business together.

Entities

A sole proprietorship is an unincorporated business owned and operated by one person. A sole proprietor may choose to operate her business without forming any type of business entity, or may choose to organize her business as a limited liability company, or LLC. An LLC is a business entity that helps protect a sole proprietor from personal liability for business obligations, but which can simply be efficient for tax and bookkeeping purposes. A single-member LLC owner who elects to have the IRS treat her business as a disregarded entity for federal taxation purposes is still considered a sole proprietor, but single-member LLC owners who elect to have the IRS treat their businesses as corporations are not considered sole proprietors. Partnerships are business entities owned by two or more individuals, according to the Revised Uniform Partnership Act, the law adopted by most states to regulate business partnerships. Legal partnerships can include limited liability partnerships, or LLPs, as well as general and limited partnerships. In some states, only certain professionals, such as attorneys or accountants, can form LLPs.

Marital Exception

Married couples filing joint tax returns who own an unincorporated business together with no other owners, and who have not organized the business as an LLP or LLC, may meet the IRS requirements of a qualified joint venture and be considered sole proprietors of their business. Married couples choosing between a qualified joint venture sole proprietorship and an LLP, or any other form of partnership, should consult a qualified tax professional, as these business entities have different record-keeping and taxation requirements and create different impacts on the couple's social security and Medicare contributions and eligibility.

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Control and Liability

A sole proprietor has complete management control over her business, but also bears the full personal liability for the business's debts including taxes and judgments against the business. An LLP must organize in accordance with state laws, and like an LLC, must register with the secretary of state. While state laws vary somewhat, most LLPs afford control over management of the business to all partners, leaving it to the partners to decide in a partnership agreement how they will divide the tasks and obligations of running the business, including the division of costs and profits. An LLP is a separate legal entity from the owners; this type of business entity helps shield the owners' personal assets from attachment to satisfy debts of the business. For someone accustomed to doing business as a sole proprietor, entering into an LLP means giving up some of the control of the business to a partner, but receiving considerable protection from personal liability for the business's obligations.

Considerations

Owners should consider several other business forms or options before making the choice between running a business as a sole proprietorship or an LLP. In addition to having the option of forming a single-person LLC, a sole proprietor may also form a subchapter S or C business corporation in which she is the sole shareholder. Each of these business forms has different annual reporting and taxation requirements. Placing assets in trust, or acquiring business insurance, are other methods by which sole proprietors may maintain sole control over a business while limited potential liability. Always consult a tax professional or business attorney in the state in which the business is formed to help make the most effective choice of entity decision for any particular business.

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