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What is Sole Proprietorship, Partnership, Corporation and Limited Liability Company (LLC)

By Jim Antonilli
Filed under: Corporations LLC

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Sole Proprietorship

A sole proprietorship is the most basic business structure in the United States. If you do not incorporate or form a partnership, the IRS will treat your business as a sole proprietorship. If you are in business with your spouse, you are still a sole proprietorship, even though both of you are in the business. If, however, you form an “informal” partnership with someone, the IRS will treat you both as sole proprietors.

This category allows almost all of the business expenses and deductions that a corporation can get. Each year when you do your personal taxes, you file an extra form, called a Schedule C, with your taxes. This is where you list your income and individual business expenses. If you make a profit, this money is added to any other money you made from salary or any other income and is taxed at the normal personal income rate. If you suffer a loss, you can deduct the loss from your salary and other income.

Partnership

A partnership is created when you sign a partnership agreement and file your taxes with the IRS as a partnership. There are several types of partnerships, but none of them are really suitable to running most types businesses. Law firms and medical practices are the most common form of partnerships.

Partnerships have several drawbacks. For one, if you are sued, each of the general partners is personally liable. For another, if you and your partner decide to part ways, dissolving the partnership can be very messy. In addition, a partnership lacks the flexibility of a corporation and does not enjoy all of the tax advantages. Finally, partnerships are considered high-value targets by IRS auditors. Partner-ships get audited on average three times more than corporations.

There are two basic types of partnerships: The General Partnership and the Limited Liability Partnership.
A General Partnership is a form of business entity in which two or more co-owners engage in business for profit. For the most part, the partners own the business assets together and are personally liable for business debts.

In the absence of a partnership agreement, profits are shared equally amongst the partners. A partnership agreement, however, can provide for a different method of sharing profits and losses.

Each partner is, jointly and severally, personally liable for the debts and taxes of the partnership. For example, if the partnership assets are insufficient to satisfy a creditor’s claims, the partners’ personal assets are subject to attachment and liquidation to pay the business debts. Each partner is also jointly and severally liable for a co-partner’s wrongdoing or tortious act (e.g., the misapplication of another person’s money or property). This is a fancy way of saying you are liable if your partner does something wrong.
The other form of partnership is a Limited Liability Partnership (LLP). This is designed for businesses such as law firms or investment companies. In an LLP, there are General Partners and Limited Partners. The General Partners run the business and share all the liability. The limited partners only share in the profits and losses.

As I stated earlier, neither of these is suitable for an online sale and marketing business. They are primarily designed for accounting and law firms, medical groups, and investment companies that employ a large number of professionals.

Corporation

A Corporation is a thing, a taxable legal entity recognized by law with tax rates separate from individual income tax rates. The corporation’s legal status also means that it is taxed separately, either under Subchapter C of the Internal Revenue Code (if it is a “C” corporation) or Subchapter S (if it is an “S” corporation). A C Corporation reports its income and expenses using federal and state tax returns, and its profits are taxed before any dividends can be distributed to the shareholders. The shareholders, in turn, must report these dividends on their individual income tax returns.

Limited Liability Corporation LLC

There is one additional type of structure. It is called a Limited Liability Corporation (LLC), and it is a hybrid between a partnership and a corporation. An LLC allows you to form a partnership with someone, vet enjoy the limited liability of a corporation. If you want to go into partnership with someone else, you might want to explore this avenue. Personally, I would always recommend becoming an S-Corp. An LLC, just like other forms of partnership, can be very messy to dissolve when the partners disagree over business issues or experience personality conflicts.

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Author: Jim Antonilli

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