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Finance & Accounting

Sole Proprietorships and Partnerships

For legal and tax purposes, sole proprietorships and partnerships must have a registered business name. A single-owner firm is known as a sole proprietorship. A lone proprietor is self-employed and is responsible for all business operations and responsibilities. A partnership is a business that is run by two or more people.

Sole Proprietorships

A sole proprietorship is owned by one person and is the most common legal form of business organization. It is the simplest legal structure where the sole owner is not legally distinct from the business.

Example: Amber Marcus Art & Design

Amber Marcus owns a graphic design business based in Seattle, WA. She gets most of her work through contract jobs with local companies. She runs the business out of her home office and is the only full-time employee. However, during the summer months, she hires a college student as an intern. As a sole proprietor, Amber has total control over every aspect of the business, and the flexibility to make changes as she sees fit.

Partnerships

A partnership is a legal structure of co-ownership between two or more people. When the business is formed, these individuals share in any profits or losses. An owner is called a partner.

Example: Stadium Bar

Amber Marcus owns a graphic design business based in Seattle, WA. She gets most of her work Stadium Bar is a Brooklyn, NY-based sports bar that is owned and operated by long-time friends Jason Cole, Seth Newton, and Nate Burgess. Established in 2007, Stadium quickly built a solid reputation in its neighborhood and is considered a local hot spot. The three men are partners in the business, and each has a role in managing the bar’s day-to-day operations. Nate serves as general partner and assumes unlimited liability for the business, but all three men share in the bar’s profits and pay taxes individually.

Sole proprietorships and partnerships can be formed quickly, easily, and inexpensively. These legal business forms offer full control to owners and face less government regulation than corporations. The owners keep all profits, which are taxed (along with any other income they may have) as personal income.

Disadvantages

Sole proprietorships and partnerships have three major disadvantages.

sole-prop-and-partnership-disadvantages-NEW

These three disadvantages lead to one major problem for sole proprietorships and partnerships: raising cash. Sole proprietorships and partnerships only have access to the owners’ personal wealth (i.e., what money the owners have or can personally borrow); this can make it difficult for them to, for example, generate the investments needed to grow.

Review Checkpoint

To test your understanding of the content presented

1. Which of the following statements are true with regard to a partnership?

  1. Profits are shared amongst all owners.
  2. Owners pay personal income tax on profits.
  3. Partnerships face more government regulation than other types of business structures.

Choose only one answer below.

a. I and II

Correct. Partners share all profits associated with the partnership. Profits are taxed as personal income. Partnerships face less government regulation than corporations. Therefore only statements I and II are true.

b. I and III

c. II and III

d. I, II, and III

2. Which of the following is the primary problem posed by the legal status of sole proprietorships and partnerships?Choose only one answer below.

a. Limited liability

b. High corporate income tax rate

c. Difficulty raising cash

Correct. Only corporations can have shareholders, and the owners of sole proprietorships and partnerships face unlimited liability for business debts. Corporations can more easily raise cash via debt or selling ownership shares.

d. Demands of shareholders

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