Going From a Partnership to a Sole Proprietorship
Partnering with another person in business can have many benefits, including combining the talents and resources of two or more individuals. However, there are times when a partnership needs to be dissolved, such as when one partner wants to retire, move on to other ventures or is dissatisfied with the relationship. Yet, one of the partners may want to keep the business going. In such cases, the partnership must be dissolved and the business may be restructured as a sole proprietorship.
The exiting partner will undoubtedly want, and be entitled to, compensation for his involvement in the partnership. Resolve how much money the partner is to receive and how that money is to be paid. The exiting partner may want certain pieces of equipment or real estate. A determination as to what the business is worth may also be required in order for one partner to “buy out” the other, and this involves such factors as inventory, property and assets and liabilities. An outside accounting firm may need to be hired to assist in such complex determinations. Another factor that must be considered is the percentage of interest each partner has in the business; it might not have been set up as a “50-50” percentage for various reasons, such as one partner initially investing more into the business.
The remaining partner, after the dissolution of the partnership, may have to make many changes. A new name for the business may need to be established, as well as a new business location, depending on the terms arrived at with the exiting partner. In the case of a name change, the new sole proprietor will have to file for a tax ID number. If the exiting partner is to receive any property, equipment, vehicles, inventory and the like, the new owner will have to make purchases to replace these items. Although not required by law, wise partners form a written agreement when forming a business partnership, clarifying the responsibilities, participation and dues expected of each partner. Hopefully, the partners can amicably arrive at dissolution terms, to make a smooth transition of ownership so that the business can continue to operate normally.
Regarding federal income tax, there are no direct tax consequences when a partnership is dissolved. A partnership, as defined by the Internal Revenue Service, pays no taxes. Although partnerships must file a federal tax return (Form 1065), income and expenses are passed down directly to each of the partners, who report their portion of the partnership’s income and expenses on 1040 Schedule E, “Supplemental Income and Loss." Similarly, a partnership return must be filed with the state, and again, the business itself pays no taxes, because income and expenses are passed through directly to each partner. Since state law governs business partnerships, you will have to check with your particular state’s website for any procedures and forms required to terminate the partnership.
The new owner of the business is now classified as a sole proprietorship (unless he opts to form a corporation). Sole proprietorships must file form 1040 Schedule C, “Profit And Loss Of A Business." All business income and expenses are reported on this form. It should be a fairly easy transition tax-wise switching from a partnership to a sole proprietorship, because the same types of daily transaction activities continue to be journaled