Incorporate your business: Sole proprietorship vs. a partnership

If you have a business now, and either work alone or have a few employees you are already a sole proprietorship.

Before starting a small business, it’s important to understand the various types of corporate structures that are available and the benefits and disadvantages of each. This is especially true in the construction industry, where exposure to financial loss can be high. Find out the advantages and disadvantages of a sole proprietorship vs a partnership.

Sole proprietorship

If you have a business now, and either work alone or have a few employees you are already a sole proprietorship. The advantages of a sole proprietorship vs a partnership include:

• No state, federal or local filing or other types of registrations are required, and there are no costs to create the business.
• Sole proprietorships are easy to maintain since no annual updates with the state are required.
• In a sole proprietorship, the owner and the business are the same entity, so the owner has total control over all business affairs.
• The owner can deduct any net business loss from personal income taxes
• The finances of the business and the owner can be intermingled as needed.

But there are also disadvantages of a sole proprietorship vs a partnership. As a sole proprietorship, you are personally liable for all debts, judgments or other potential liabilities of the business. Anyone in the construction industry knows that accidents can occur at any time and can have severe consequences. Even with insurance, a major accident claim can exceed your coverage limits, and often businesses are sued, even though they were not at fault. The bottom line is there is no personal protection for the owner of a sole proprietorship.

A second disadvantage of a sole proprietorship vs a partnership is that as a sole proprietorship, you must pay personal income and self-employment taxes for all net business profits. Your self-employment taxes (FICA and Medicare) will be approximately twice the amount you would pay if you were an employee of a company.

While no federal or state registrations are required for a sole proprietorship, if your business has employees or hires subcontractors, you will need a Federal Tax ID number (also known as FEIN). Any subcontractors you hire, that are not incorporated, must be issued a Form 1099 at the end of each tax year for any subcontracts in excess of $600. This applies to all of the following business structures, as well.

General partnership

General partnerships are basically identical to sole proprietorships except that there are two or more owners that share the rewards and risks. While the advantages and disadvantages are the same as with a sole proprietorship, there is one major additional disadvantage.

Owners of a general partnership are jointly and personally liable for all debts, judgments and liabilities of the business. As an example, if you are 50/50 partners in a business and the business incurs a loss or judgment against it and your partner doesn’t have the money to pay their half of the debt, you are responsible for the entire amount.

Continued at: Part 2: Limited liability corporations and S corporations

−By Bruce Webb