Differences Between a Sole Proprietorship and a Partnership

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'll 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.

What Is a Sole Proprietorship?

As soon as you start doing business by yourself, whether you accept money to mow your neighbor's yard or 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 limited liability companies (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 don't file any formation paperwork.

When you form a sole proprietorship, although you're the only owner, you don't have to work alone. You can hire employees, freelancers, and consultants to help run your business. However, you're the one responsible for making the decisions for the business and all of the profits and losses will go to you.

What Is a Partnership?

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 don't 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.

Partnership Agreements

The law doesn't require partnerships to have a partnership agreement, but creating one can help you clarify each partner's expectations and roles within the business.

In the agreement, you can specify:

• how the partners will share responsibilities, profits, and losses
• when and how the partnership can end, and
• whether partners can transfer their interests in the business to third parties (also known as a "buyout agreement").

Business Licensing and Names

Sole proprietorships and partnerships have the same responsibilities when it comes to business licenses and name registrations.

Business licenses and permits. Although you don't file formation paperwork with the state to form a sole proprietorship or a partnership, you're not off the hook for other business licenses or permits. Some towns and counties require all businesses to obtain a local general business 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.

DBAs. 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. You'll usually apply for a DBA at the county or state level. Check your secretary of state's website for more information.

Personal Liability for Business Debt

Neither sole proprietorships nor partnerships shield the owners from the obligations of the business. Instead, owners of these two entity types are personally responsible for their business's debts and obligations. 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 doesn't distinguish between you and your business. When the business owns property, so do you. For example, if someone files a lawsuit against a partnership or a sole proprietorship, the owners will have to pay any judgment and fees.

When you form a partnership, you could be personally responsible for anything your partner does in the course of running the business. However, you won't be responsible for all of your partner's actions. For example, if your partner caused a car accident while on vacation, your personal assets wouldn't be on the line to pay for the damage caused by the accident. However, if your business is a delivery service, and your partner crashes the business truck while on a delivery to a customer, you might be personally liable.

You can allocate responsibility for business debts with a partnership agreement.

Sole Proprietorship and Partnership Taxes

Both business types are "pass-through entities," meaning the business doesn't pay corporate tax. Instead, the income "passes through" the entity, and the owners pay taxes on their personal tax returns. 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. For more information on pass-through taxation, read our article about avoiding double taxation for business income.)

While the IRS taxes each entity similarly, how the owners of each entity report their income is different:

• Sole proprietors report profits and losses from their business on their personal tax returns, using Schedule C. They submit only one return.
• Partnership owners file two returns: They submit Form 1065, which is its own informational tax return. Because the partnership has allocated a portion of the profits and losses to each partner, each partner reports their portion on their personal tax returns, using Schedule E.

Final Guidance on Sole Proprietorships and Taxes

Each business structure has its own advantages and disadvantages. Sole proprietors and general partners don't have limited personal liability but they also don't have to create or maintain governing documents for their business. LLCs and corporations do have limited liability but they're more expensive to maintain and must follow specific formation rules. You should choose which type of business works best for your priorities as a business owner.

If you have legal questions about which business structure to form, talk to a business attorney. They can advise you on the benefits and drawbacks of each entity type, help you file the required paperwork to register and license your business, and help you set up your organizational documents.