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Sole proprietorships and general partnerships are efficient and easy to form. These types of business formations may require minimal formal paperwork prior to commencing operations. Choosing a certain type of business formation may have unique income tax and legal repercussions. It is best to consult an accountant and a lawyer prior to making a final decision. General partnerships are generally more complicated and may involve more formal paperwork than sole proprietorships.
Both sole proprietorships and partnerships place full debt and legal liability onto the shoulders of the operators. This means that if creditors need to recover bad debts incurred by the business, the operators' personal assets may be at risk. In the event of a lawsuit against the business, the operators assume full responsibility for any financial obligations that may be a part of a judgment. The business and the operator(s) are the same entity in the eyes of the law.
The government requires that business owners report profits from sole proprietorships and partnerships on their personal income tax forms. Both sole proprietorships and partnerships do not pay corporate income tax. The owners pay taxes on earnings from the business or receive a deduction for any losses. In a general partnership, the percentage of business income or loss reported on individual tax returns may differ according to the partnership agreement. For example, one partner may receive and report 60 percent of the company's profit or loss, while the other partner receives and reports 40 percent.
The federal government does not require that sole proprietorships file any type of annual report. In contrast, general partnerships must file an annual return with the Internal Revenue Service (IRS). The return indicates the company's annual income, tax deductions, gains and losses from operations. This is merely part of a check and balance system which ensures that each partner accurately reports the correct amount on his individual tax return. According to the IRS, partnerships may need to file forms 1065, 940, 941, and 8109-B.
Ownership and Responsibility
One owner and operator forms a sole proprietorship. A single individual makes all of the strategic decisions related to the business. In a sole proprietorship, one person receives the profits. Sole proprietors may operate out of their homes. General partnerships involve two or more owners. Partners may have a written or implied verbal agreement with each other. One owner may only handle certain aspects of the business, such as sales. Partners may equally contribute to start-up costs or one owner may finance a larger portion of the company's operations.