Starting a business can be an adventure for many individuals, but it starts with deciding on how the business will be organized. Choosing whether to be a sole trader or whether to be involved in a partnership can be challenging for those unfamiliar to these types of business entities. Recognizing the advantages and disadvantages of both these entities can help one create the right business that will create and keep profit.
A sole trader is an individual who owns a business entirely by himself. The business and this person is one, meaning that both the company's profit and liability belong to the individual. The benefit of owning a sole trading company is that the sole trader has the right to make all decisions regarding the business.
A partnership is a business entity comprised of two or more individuals. Sometimes partnerships are limited, meaning that one of the individuals is only investing in the business while the other individual is actually running the business. This business entity should always record their terms of partnership in a contract.
Because a business has risks, those who own the business can be liable for those risks. If a sole trading company were to accrue debts, the sole trader would become personally liable for paying those debts. The partners in a partnership can also be subject to personal liability as well, however, there are two caveats to this rule.
Personal liability in a partnership is shared, meaning that all parters will be liable to cover the company's debts. Furthermore, if the partners formed a limited partnership, only the partner who ran the business would be liable, not the partner who just invested in the business. Therefore, forming the right type of partnership can help avoid personal liability, which is unavoidable with a sole trading company.
Both sole traders and partnerships must pay quarterly tax payments to the IRS each year. The tax filing process is rather simple, and the IRS calls both entities “pass-through entities”. These entities’ income pass down to the owners who report the business profits or losses on their individual tax returns. Both entities, however, should keep accurate records to receive the most deductions possible that will lower tax liability.
A sole trader will file the individual tax form 1040, ensuring that Schedule C (Profit or Loss from a Business) of this form is completed. Partnerships will file form 1065, U.S. Return of Partnership Income, as well as individual 1040 tax return forms.