When forming a business, there are several business types to choose from. Popular business structures include corporations, limited liability companies (LLCs), and S-corporations. For business owners looking to keep things simple, however, a sole proprietorship or a general partnership may be the best option. Here's what you need to know about these business structures, as well as the similarities and differences between them.
What is a sole proprietorship?
As the name implies, this is a business structure where there is a single owner and operator. All of the profits go to one person, and this person is also responsible for making all business decisions. A sole proprietorship doesn't require any formal action to set up, but depending on the nature of your business, you may still need to obtain licenses or permits.
For tax purposes, income from a sole proprietorship is reported on the owner's personal tax return -- no corporate tax return is required. Business income from a sole proprietorship is recorded on IRS Schedule C and is transferred to Form 1040. Sole proprietors are responsible for paying all necessary taxes on their business income, including federal and state income taxes, self-employment taxes, and estimated tax payments.
What is a partnership, and how is it different?
The most obvious difference is that a partnership involves two or more people who are in business together, based on a written or verbal agreement. Partners generally share the duties involved with running the business, or they may have specific individual responsibilities outlined in the partnership agreement.
Partners may each own an equal share of the company, or they may have different shares, but this must be documented in a written agreement. For example, if three people form a general partnership, but one partner puts up half of the total capital, there could be a 50%/25%/25% equity split.
Taxation works in mostly the same manner as it does with a sole proprietorship. The business' profits are passed through to the owners and are reported on their personal tax returns. However, partnerships are typically required to register with the state and to obtain a federal tax ID number and file a business return with the IRS each year as a way of ensuring that all of the business' profits are claimed among the partners.
One big disadvantage
While these business structures are relatively easy to set up and maintain, the main drawback is the amount of personal liability that comes with them. Specifically, a sole proprietor's or partner's assets may be at risk if the business gets sued or takes on debt. With other business structures, such as an LLC or corporation, personal assets are protected from liability for debts and legal costs.
If you have a relatively simple business, where your assets will most likely not be at risk, then a sole proprietorship or partnership may be right for you and/or your partners.
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