The Sole Proprietorship vs Partnership dilemma is one most small businesses face when trying to decide how to structure their companies. Imagine this: you’ve moved beyond gifting your homemade jewelry to friends and family and have bravely decided to take your talents online.
As an individual starting your own business, there are many considerations to take into account — the first being the opportunity to register your business under a specific entity, such as a Corporation or Limited Liability Company (LLC).
Your choice of entity type depends on your preferences regarding taxation, legal protection, and control of the business. (More on entity types here).
If you opt out of incorporating or registering as a Limited Liability Company, then your business can either be a Sole Proprietorship or a Partnership. What are these two entities, and which one fits your business best?
Let’s find out.
What is a Sole Proprietorship?
A “Sole Proprietorship” may sound complicated, but it’s nothing more than jargon for an individual who owns a business and is personally liable for its debts.
For instance, if you’re running a jewelry business, you may need to buy materials, maintain and promote your shop, and eventually hire an employee or two to manage orders.
As a Sole Proprietor, you are personally responsible for these costs, as well as any debts incurred while operating your business. Some of the characteristics of a Sole Proprietorship include:
- Single ownership
- Unlimited liability
- One man’s capital
- No sharing of profit or loss
- Less legal formalities
Image via GovDocFiling
Also Read:
- Single Member LLC vs. Multi Member LLC: How to Choose in 2024
- Sole Proprietorship vs S Corp: Pros & Cons of Each
Key Elements of a Sole Proprietorship
Here are the main features of a Sole Proprietorship business.
Easy Set-Up
Sole Proprietorships are easy to set up and can cost significantly less to maintain than other business entity types. It has one owner and very few legal formalities are required during formation, management, and dissolution.
Taxation for this type of enterprise is also simple. Other than an EIN/Tax ID, Sole Proprietorships don’t require additional formation documents by the state or IRS. This is because they do not need to file separate business returns.
This makes them the most common type of business ownership in the United States.
Sole Ownership
Sole Proprietors tend to run small or part-time businesses and typically have few or no employees. Despite having employees, they’re owned by one person and one person only.
This means that the business owner is solely responsible for decision-making, implementation of decisions, and management of the business. This way, there are no conflicts unlike in other forms of business ownership.
Unlike other entity types, a Sole Proprietorship ceases to exist when the business owner dies, retires, or decides to sell the business.
Unlimited Liability
As a Sole Proprietor, you are 100 percent liable for any and all business debts. Your business is not a separate legal entity from you, i.e., a sole proprietor and their business are one and the same person.
This means that if the business goes south, you open yourself up to lawsuits that, if won, will jeopardize your personal assets. For example, if someone sues your business and wins, they can go after your home, car, savings etc.
In other business entities such as LLCs, Corporations, and some forms of Partnerships, business owners’ personal assets are shielded by a limited liability clause.
Pass-Through Taxation
A Sole Proprietorship is recognized as a legal entity but is legally and financially indistinguishable from its owner. This means you must report the net profits or losses of your business on your personal income taxes (known as “pass-through taxation”).
In addition, you are required to pay a self-employment tax of 15.3 percent to the federal government.
Profits
A Sole Proprietor does not have to share their business profits. While you may need to pay employees or repay debts, what you do with the proceeds from your business is totally up to you. For instance, a Sole Proprietor may decide to plow back their business’s profits or take a higher salary.
Sole Proprietorships offer unmatched flexibility. You have unlimited control over your business, its proceeds, k1, and its resources.
If and when a Sole Proprietor offers partial ownership to another business or person, the company will no longer be treated as a Sole Proprietorship but as a Partnership.
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- Steps to Starting an LLC in 2024 (Limited Liability Company)
What is a Partnership?
A Partnership is formed by two or more parties who have agreed to co-own a business, contribute financially, and take up management and decision-making responsibilities for profit-making.
Just like Sole Proprietorships, Partnerships do not need a lot of legal formalities during formation or taxation. They can be based on a legal agreement or an informal conversation.
They’re easy to set up as well, although formation regulations may vary by state. Unlike Sole Proprietorships, you’ll share losses and responsibilities with your partners. Partnerships also have more access to resources, skills, contacts, and knowledge.
In a nutshell, the characteristics of Partnerships include:
- Joint personal liability
- Pass-through taxation
- Flexibility and simplicity
- Shared ownership
- Limited lifespan
Image via GovDocFiling
Key Elements of a Partnership
A Partnership features these main characteristics:
Mutual Agency
Partners are agents of the Partnership and can act on its behalf for the good of the business. For instance, a partner can get into a contractual agreement with another Partnership that will legally bind the business and the other partners.
However, a Partnership agreement may limit partners from getting into a contract on behalf of the company.
Ease of Formation
A Partnership is easy to form and does not involve many legal formalities. As it’s not a legal business structure, it’s got fewer complications in the formation and running process. You could consider them as Sole Proprietorships, but with multiple owners. Partnerships also enjoy pass-through taxation.
Unlimited Liability
Depending on the type of Partnership you form, some or all partners may be liable for the business’s debts. In General Partnerships, for instance, every individual partner may need to use their personal assets to settle the business’s obligations.
Sometimes when one partner’s assets are not enough to settle their share of business debt, other partners may be required to chip in.
Limited Life
Since Partnerships are unincorporated, an agreement or the partners themselves may limit its existence. For instance, the death, incapacitation, bankruptcy, or the withdrawal of a partner may lead to the dissolution of the Partnership.
With a withdrawal or addition of a new Partnership, the business is often required to draw up a new Partnership agreement.
Depending on the provisions of the Partnership, the business can go on even when one partner withdraws for whatever reason.
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- How to Open a Small Business in Florida in 2024 – 9 Steps
- Incorporate in Texas: 7 Easy Steps for Entrepreneurs in 2024
Sole Proprietorship vs Partnership: The Differences
Partnerships and Sole Proprietorships have a few differences.
| Partnership | Sole Proprietorship | |
| Structure | Involves more than one person. Partnerships may feel the need to outline terms to minimize conflict. | Involves only one person. No need for terms or rules as decision-making power lies solely with the owner. |
| Liabilities | Owners share any legal liabilities, either equally or depending on their contributions and stake in the business. | A Sole Proprietor is personally responsible for all business’s liabilities. |
| Taxes | Each partner reports their share of Partnership income in their personal income tax returns. The business doesn’t pay any tax. | Sole Proprietors only submit one return, reporting the profits and losses from their business in their personal tax return. |
| Ownership | Partners co-own a business and may share the management of the business, general duties, and decision-making. | A Sole Proprietor is responsible for the management of the business, decision-making, and other roles as the sole owner. |
| Financing | Partners have access to a larger pool of resources, both in finances and other assets, as they can make capital contributions etc. | Besides external sources of funds, Sole Proprietorships have less access to funds as the owner is responsible for both capital and operational financing. |
| Dissolution | Partnership dissolution terms may be stated in a Partnership agreement. The state also outlines laws for the same. Lastly, you’ll need to file for a certificate of cancellation with your state. | You’ll only need to notify the IRS and local tax authorities that you’ve ceased operations. You’ll also need to file final forms and schedules before you can have your account closed. |
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- What Kind of Business Structure Do Investors Prefer?
- Does Changing the Name and Structure of My Business Require a New EIN?
Sole Proprietorship vs Partnership: Similarities
Here are some similarities between Sole Proprietorships and Partnerships.
| Personal Liabilities | Neither Partnerships nor Sole Proprietorships structures shield their owners’ personal assets from business debts. |
| Taxation | Both Sole Proprietorships and Partnerships enjoy pass-through taxation, meaning they’re not required to pay corporate taxes. |
| Formation Paperwork | You will not need to file formation paperwork with your state for either Sole Proprietorships or Partnerships |
| Business Licenses | Both businesses may be required by the state, towns, or counties to acquire some business licenses or permits. You may also need specialized permits depending on the goods or services you provide. |
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- 4 Key Tax Benefits of an LLC for Your Rental Property (2024)
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Sole Proprietorship vs Partnership: Pros and Cons
When comparing a Sole proprietorship vs Partnership, it’s essential to weigh the advantages and disadvantages of each business structure. By assessing these key aspects, you are better placed to determine which option better aligns with your needs.
Sole Proprietorship Pros
- Easy Setup: Simple to establish with minimal paperwork and low costs.
- Full Control: The owner has complete control over all decisions.
- Simplified Tax Reporting: Business income is reported on the owner’s personal tax return.
- Privacy: No public disclosure of financial information is required.
- Flexibility: Easy to adapt the business model or pivot as needed, without needing approval from others.
Sole Proprietorship Cons
- Unlimited Liability: Personal assets are at risk if the business faces debt or legal issues.
- Limited Capital: Funding options are restricted, often relying on personal savings or loans.
- Lack of Continuity: The business may dissolve if the owner retires or passes away.
- Burden of Responsibility: The owner manages all aspects of the business, leading to potential burnout.
- Growth Challenges: Limited resources can hinder expansion and attracting top talent.
Partnership Pros
- Shared Responsibility: Partners can divide tasks based on their strengths, making management easier and more efficient.
- Increased Capital: With multiple partners, there’s greater potential to pool resources and access funding.
- Combined Expertise: Partners bring diverse skills and knowledge, enhancing decision-making and business strategy.
- Easier Continuity: A partnership can continue even if one partner leaves, provided there’s an agreement in place.
- Tax Benefits: Partnerships often benefit from pass-through taxation, avoiding double taxation at the corporate level.
Partnership Cons
- Unlimited Liability: Like sole proprietorships, partners are personally liable for business debts, potentially putting personal assets at risk.
- Potential Conflicts: Differences in opinions or goals among partners can lead to disputes, which may harm the business.
- Shared Profits: Profits are split between partners, which may limit individual earnings compared to sole proprietorships.
- Complex Decision-Making: Decisions often require consensus, which can slow down processes and hinder quick actions.
- Legal and Financial Complexity: Requires detailed agreements to outline roles, profit sharing, and dispute resolution, which can be costly and time-consuming to set up.
When deciding between a Sole Proprietorship vs Partnership, consider your business goals, risk tolerance, and desired level of control. As we’ve seen, both structures have their merits and drawbacks, so carefully evaluate which aligns best with your vision.
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The 411 on EIN
Regardless of your entity type, you will need a unique number — known as an Employer Identification Number (EIN) or Tax ID — to identify your business to the government and the IRS.
In some cases, you are able to use your Social Security Number (SSN) to identify your Sole Proprietorship; however, if you plan to hire employees, establish payroll, open a bank account in your company’s name or acquire credit, you will need an EIN/Tax ID.
Even if you don’t need one today, there’s no harm in applying for an EIN and having it available should you need to do any of the aforementioned tasks. The following graphic outlines the various methods available for applying for an EIN — Online, Fax, Mail, and Phone — allowing you to choose the option that best fits your needs.
Image via GovDocFiling
A tax ID can come in handy when trying to conceal your personal Social Security Number on invoices and other business forms. Partnerships also need an EIN, for similar reasons, even if they don’t plan on hiring employees. Unlike Sole Proprietorships, they need to register with the IRS for a separate tax ID as well so they can report federal taxes.
Note: Individuals are only allowed one Sole Proprietor EIN/Tax ID in their lifetime. If you applied for/received a Tax ID but no longer need it or would like to get a different EIN for another purpose, you will need to cancel the original EIN with the IRS.
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What’s in a Name?
As a Sole Proprietor, the legal name of your business is your name — exactly the way you listed it on your Tax ID application. The legal name of a Partnership is the name provided by the owner(s) for state filings.
You have the option of filing for a fictitious trade name or a DBA (“Doing Business As”), which allows you to choose a different business name you wish to be recognized by.
A DBA can even be required for business bank accounts opened for Partnerships if you want all partners to have access to the account. Whichever name you choose, you will need to file the appropriate forms with the county in which you are conducting business.
When selecting a name in the process of opening a business, it’s crucial to consider several factors that go beyond just personal preference. The graphic below outlines four key elements — uniqueness, relevancy, domain availability, and brandability — that balance uniqueness with practicality and brand potential.
Image via GovDocFiling
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Types of Partnerships
Here are the four main types of Partnerships:
1. General Partnership
If you share ownership of your business with at least one other person, you are considered a General Partnership.
This is the most basic form of Partnership that exists. They’re the easiest to form and end.
Unless otherwise specified in a Partnership agreement, general partners evenly share responsibility, profits, and losses. Partners also have independent power to act and get into contracts with third parties on behalf of the business.
Each partner is fully liable for the business’s debts and legal obligations. This means that in case one partner takes out a loan that the business can’t repay, all the partners would have to contribute to settling the debt.
In most cases, the death, bankruptcy, or incapacitation of a general partner ends the Partnership.
2. Limited Partnership
In this form of Partnership, there’s at least one general partner who is fully responsible for the business. It also has one or more limited partners, who provide financial contributions and are not actively involved in the business’s day-to-day activities.
The limited partner is also known as a silent partner. Their liability is limited to their contributions, meaning that they cannot lose more than they invested. In some states, limited partners do not qualify for pass-through taxation for this reason.
3. Limited Liability Partnership
With limited liability, partners are actively involved in the management of the business just like in general Partnerships. However, they have limited liability protection against each other’s actions.
Partners are still fully responsible for the business’s debts and legal liabilities, but not for the mistakes of other partners. These types of Partnerships are common with professional businesses such as law firms and accounting firms.
Limited Liability Partnerships are not available in some states.
4. Limited Liability Limited Partnership
A Limited Liability Limited Partnership works much like the Limited Liability Partnership. It, however, shields both general and limited partners from liability. It’s also not recognized in all states, so you’d need to confirm with your state before formation.It’s also not suitable for Partnerships planning to operate in different states.
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Types of Sole Proprietorships
Sole proprietorships also come in a number of different types. These include.
1. Self-Employment Owner
Self-employed Sole Proprietors conduct and carry out business for profit. They do not get into any form of contractual agreements with their customers, nor do they get into employment agreements.
Self-employed Sole Proprietors can either choose to do business full-time or part time. Such businesses typically include retail shops, offering services like plumbing, selling merchandise online, and so forth.
2. Freelancer or Independent Contractor
Freelancers and independent contractors are also Sole Proprietors whose functions closely resemble those of employees.
Independent contractors are hired by companies for certain functions, but their contracts do not include any benefits, and their taxes are not withheld. Independent contractors or freelancers can decline or accept assigned tasks.
A freelancer also has much more control over their work as opposed to employees. Nonetheless, they’re business owners who have no employees.
3. Franchise
Franchises also often take the form of a Sole Proprietorship. Here, the Sole Proprietor is referred to as a franchisee, and they pay a fee to the franchisors so they can use their company brand.
The franchise has to follow a set business model for its marketing, pricing, operations, and expansion needs. Franchisees are also obligated to pay their franchisors a certain percentage of revenue in royalties.
This type of Sole Proprietorship is good for inexperienced business owners as they’ll follow a pre-existing, successful business model.
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- Freelance LLC Guide: Everything You Should Know in 2024
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FAQs
1. What is better, Sole Proprietorship or Partnership?
A. The choice between Sole Proprietorship vs Partnership depends on your business needs as both business forms have their distinct advantages and disadvantages. For instance, while Sole Proprietorships give you maximum flexibility, you’ll have more access to funds in a Partnership.
2. How does a Sole Proprietorship differ from a Partnership?
A. A Sole Proprietorship is a simple, single-owned business entity that is managed by one person and is legally indistinguishable from the owner. A Partnership is owned by more than one person, with shared profits, losses, and liability and is governed by the Partnership Act.
3. Can a married couple operate a business as a Sole Proprietorship or do they need to be a Partnership?
A. Unless the business meets the qualifications set by the IRS for joint ventures, businesses operated by spouses will be treated as a Partnership. That’s unless one spouse operates the business and the other works as an employee.
4. Can I change a Sole Proprietorship to a Partnership?
A. Since Sole Proprietorships aren’t created through any formal process, there’s no need to dissolve one to start a Partnership. You can transition from a Sole Proprietorship to a Partnership easily.
5. Which one is riskier, a Partnership or a Sole Proprietorship?
A. Sole Proprietorships are riskier since the responsibility of the entire business lies with the single owner. They get to make all the decisions, take all the losses, and take care of the financing. Partners share the burden of responsibility and bring in more finances, skills, and experience.
Ready to Start Your Small Business?
Starting a business alone for the first time can be intimidating considering the legal implications of it all. Hopefully, this post solves the Sole Proprietorship vs Partnership confusion and helps you determine which structure best suits your business needs.
If you’re still unsure whether or not your business qualifies as a Sole Proprietorship, Partnership, or something else, take our quick survey to determine your entity type.
About the author
From selling flowers door-to-door at hair salons when he was 16 to starting his own auto detailing business, Brett Shapiro has had an entrepreneurial spirit since he was young. After earning a Bachelor of Arts degree in Global and International Studies from the University of California, Santa Barbara, and years traveling the world planning and executing cause marketing events, Brett decided to test out his entrepreneurial chops with his own medical supply distribution company.
During the formation of this business, Brett made a handful of simple, avoidable mistakes due to lack of experience and guidance. It was then that Brett realized there was a real, consistent need for a company to support businesses as they start, build and grow. He set his sights on creating Easy Doc Filing — an honest, transparent and simple resource center that takes care of the mundane, yet critical, formation documentation. Brett continues to lead Easy Doc Filing in developing services and partnerships that support and encourage entrepreneurship across all industries.