Partnerships share many similarities with sole proprietorships—the key difference is that the business has two or more owners. There are two kinds of partnerships: general partnerships (GPs) and limited partnerships (LPs). In a general partnership, all partners actively manage the business and share in the profits and losses.
Like a sole proprietorship, a general partnership is the default mode of ownership for multiple-owner businesses—there’s no need to register a general partnership with the state.
Most people form partnerships to lower the risk of starting a business. Instead of going all-in on your own, having multiple people sharing the struggles and successes can be very helpful, especially in the early years.
This being said, if you do go this route, it’s very important to choose the right partner or partners. Disputes can seriously limit a business’s growth, and many state laws hold each partner fully responsible for the actions of the others. For example, if one partner enters into a contract and then violates one of the terms, the third party can personally sue any or all of the partners.
Unlike a general partnership, a limited partnership is a registered business entity. To form an LP, therefore, you must file paperwork with the state. In an LP, there are two kinds of partners: those who own, operate, and assume liability for the business (general partners), and those who act only as investors (limited partners, sometimes called “silent partners”).
Limited partners don’t have control over business operations and have fewer liabilities. They typically act as investors in the business and also pay fewer taxes because they have a more tangential role in the company.
Multi-owner businesses that want to raise money from investors often do well as LPs because investors can avoid liability.
You might come across yet another business entity structure called a limited liability partnership (LLP). In an LLP, none of the partners have personal liability for the business, but most states only allow law firms, accounting firms, doctor’s offices, and other professional service firms to organize as LLPs. These types of businesses can organize as an LLP to avoid each partner being liable for the other’s actions. For example, if one doctor in a medical practice commits malpractice, having an LLP lets the other doctors avoid liability.
A C-corporation is an independent legal entity that exists separately from the company’s owners. Shareholders (the owners), a board of directors, and officers have control over the corporation, although one person in a C-corp can fulfill all of these roles, so it is possible to create a corporation where you’re in charge of everything.
This being said, with this type of business entity, there are many more regulations and tax laws that the company must comply with. Methods for incorporating, fees, and required forms vary by state.
Most small businesses pass over C-corps when deciding how to structure their business, but they can be a good choice as your business grows and you find yourself needing more legal protections. The biggest benefit of a C-corp is limited liability. If someone sues the business, they are limited to taking business assets to cover the judgment—they can’t come after your home, car, or other personal assets.
This being said, corporations are a mixed bag from a tax perspective—there are more tax deductions and fewer self-employment taxes, but there’s the possibility of double taxation if you plan to offer dividends. Owners who invest profits back into the business as opposed to taking dividends are more likely to benefit under a corporate structure. Corporation formation and maintenance can be complicated, but online legal services like LegalZoom, Avvo, and Incfile can help with these things.
An S-corporation preserves the limited liability that comes with a C-corporation but is a pass-through entity for tax purposes. This means that, similar to a sole prop or partnership, an S-corp’s profits and losses pass through to the owners’ personal tax returns. There’s no corporate-level taxation for an S-corp.
In order to organize as an S-corporation or convert your business to an S-corporation, you have to file IRS form 2553. S-corporations can be a good choice for businesses that want a corporate structure but like the tax flexibility of a sole proprietorship or partnership.
A limited liability company takes positive features from each of the other business entity types. Like corporations, LLCs offer limited liability protections. But, LLCs also have less paperwork and ongoing requirements, and in that sense, they are more like sole proprietorships and partnerships.
Another big benefit is that you can choose how you want the IRS to tax your LLC. You can elect to have the IRS treat it as a corporation or as a pass-through entity on your taxes.
LLCs are popular among small business owners, including freelancers, because they combine the best of many worlds: the ease of a sole proprietorship or partnership with the legal protections of a corporation.
With a better understanding of how the common business entity types work and their respective pros and cons, you can now determine which type works best for your small business. The best course of action, if you can afford it, is to consult a business lawyer and tax professional on which structure is optimal for you, given where your business is currently and where you hope to take it.
As a starting point, however, there are three general factors to consider when choosing among business entity types: legal protection, tax treatment, and paperwork requirements. In the table below, you can see how the entities stack up with regard to each of these factors.
With a better understanding of how the common business entity types work and their respective pros and cons, you can now determine which type works best for your small business. The best course of action, if you can afford it, is to consult a business lawyer and tax professional on which structure is optimal for you, given where your business is currently and where you hope to take it.
As a starting point, however, there are three general factors to consider when choosing among business entity types: legal protection, tax treatment, and paperwork requirements. In the table below, you can see how the entities stack up with regard to each of these factors.
As you can see, sole props and GPs are light on liability protections, so they expose you to greater legal risk if someone sues your business. But, taxation is simple when you have a sole prop or GP, and you don’t have nearly as many government regulations to comply with. That means more time to do what you love—running your business.
This being said, the simplicity of a sole prop or a partnership makes either of these business entity structures a good starting point for freelancers and consultants, particularly if the industry they’re in brings little legal risk with it.
Along these lines, fashion and beauty influencer Joanna Faith Williams told Fundera: “Being a sole proprietor now seems most appropriate as there is not much that I am liable for at this time. I keep well-written contracts to protect myself, but as I begin to dive more into creating content such as ebooks… or things that my audience will have to pay for, I will definitely consider registering as an LLC.”