Sole proprietorships and partnerships are common business entities that are simple for owners to form and maintain. The main difference between the two is the number of owners. With a sole proprietorship, you are the sole owner (in some states, your spouse may be a co-owner). When you have a partnership, you will work with at least one co-owner. Owning a business with someone else invites additional concerns, such as handling conflicts among the owners and allocating responsibilities, profits, and losses.
As soon as you start doing business by yourself, whether you accept money to mow your neighbor’s yard or you sell your homemade jewelry online, you have a sole proprietorship. In some states, if you co-own a business with your spouse, your business is still a sole proprietorship. For some business entities, like corporations and LLCs, you have to file formation documents with the state (such as Articles of Organization) to create the business. By contrast, you create a sole proprietorship as soon as you accept money for your goods or services, and you do not file any formation paperwork.
When you form a sole proprietorship, although you are the only owner, you do not have to work alone. You can hire employees, freelancers, and consultants to help run your business. However, you are the one responsible for making the decisions for the business and all of the profits and losses will go to you.
When you and someone else start doing business with the intent of making a profit, you have a partnership, sometimes referred to as a general partnership. The partnership might begin with signing an agreement to work together, or you could have an informal relationship based on a conversation and a handshake. Your partner could be an individual or a business, and you can have an unlimited number of partners. As with sole proprietorships, you do not file anything with the state to form a partnership.
The benefit of a partnership over a sole proprietorship is that you’ll share the responsibilities, resources, and losses. On the other hand, you also split your profits, and you might face disagreements over how to run the business. One way to mitigate conflict is to create a partnership agreement.
The law does not require partnerships to have a partnership agreement, but you could benefit from creating the document to clarify each partners’ expectations and roles within the business. In the agreement, you can specify how the partners will share responsibilities, profits, and losses. You can provide for when and how the partnership can end, and whether partners can transfer their interests in the business to third parties. You can read more about partnership agreements here.
Sole proprietorships and partnerships have the same responsibilities when it comes to business licenses and name registrations. Although you don’t file formation paperwork with the state to form a sole proprietorship or a partnership, you are not off the hook for other business licenses or permits. Some towns and counties require all businesses to obtain a local license or permit. Depending on the goods or services you provide, you might need specialized licenses from government agencies, such as a food handler’s permit or a license to sell cannabis.
If you want to do business under a name other than your own or your partner’s, you must file for a Doing Business As (DBA) or a Fictitious Business Name. Check with your Secretary of State for more information.
Neither sole proprietorships nor partnerships shield the owners from the obligations of the business. Creditors can go after your personal assets like your home, bank account, and your car to pay for the debts of the business. The law does not distinguish between you and your business. When the business owns property, so do you. Bringing a lawsuit against a partnership or a sole proprietorship is the same as suing the owners.
When you form a partnership, you could be personally responsible for anything your partner does in the course of running the business. However, you will not be responsible for all of your partner’s actions. For example, if your partner caused a car accident while on vacation, your personal assets would not be on the line to pay for the damage caused by the accident. However, if your business is a delivery service, and your partner were to crash the business truck while on a delivery to a customer, you might be personally liable.
Both business types are “pass-through entities,” which means that the business does not pay corporate tax. Instead, the income “passes through” the entity, and the owners pay taxes on their personal tax return. Owners of both entities pay self-employment tax on their portion of the income but can enjoy the 20% pass-through deduction to reduce their personal tax burden, which you can read more about here.
While the IRS taxes each entity similarly, how the owners of each entity report their income is different: