What is a sole proprietorship?
When a person decides to go into business on his or her own, typically, a sole proprietorship is created. This is the simplest type of legal entity for individual business owners. The primary characteristic of the sole proprietorship, as the name suggests, is that the business is owned by a single individual, who retains complete control over the direction and development of the business. In addition to the high amount of control given to the owner, this type of entity is very easy and inexpensive to form. There are no formal filings or fees to pay other than obtaining any necessary business licenses and permits.
How can it limit my business?
While giving the owner a great deal of control, the sole proprietorship has a number of drawbacks. Most importantly, the sole proprietor is personally responsible for everything related to the business. All expenses, including any taxes, are “passed-through” to the sole proprietor. As a result, the owner is accountable for any debt the business incurs. In the event of a lawsuit, the owner can be held personally liable and runs the risk of losing everything he or she personally owns. In addition to liability and expenses, this structure may prevent the owner from taking advantage of a number of tax and other benefits available to members of other types of entities.
What if I have a business partner?
When two or more people go into business together, a partnership is formed, and the partners maintain broad control of the business. In most instances, the partnership is governed by the partnership agreement. In the absence of an agreement, however, all partners own an equal portion of the business and share equally on the profits and control of the business. Another advantage of the partnership is that it can accumulate assets and incur debt in its own name. This is different from the sole proprietorship, where everything is in the name of the owner.
What are the risks of partnerships?
As with the sole proprietorship, each partner is personally responsible for everything that has to do with the partnership and all bear the risk if the business fails or in the event of a suit. The partners assume additional risk as each may be found personally liable for the acts of the other partners. In terms of tax liability, the partnership is also a pass-through entity, which means that taxes are reflected in each partner’s individual tax returns.
In the next installment we will discuss the limited partnerships and limited liability companies.
Maria de L. Mojica is an associate in the Corporate department of Whiteford, Taylor & Preston, you can contact Maria at mmojica@wtplaw.com or 410-659-6403
Joseph L. Morales is an associate in the Technical and Intellectual Property section of Whiteford, Taylor & Preston, you can contact Joe at jmorales@wtplaw.com or 410-659-6428
The commentary described in this article does not constitute legal or tax advice. It is not intended to be a comprehensive evaluation of the state of the law and there may be additional requirements depending on the type of business in which your company is engaged. It is only for information purposes only. Readers must consult their tax and legal advisers for the appropriate entity for their business and for any tax implications related to them.
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