Difference between sole proprietorship partnership and corporation

Business owners have several options from which to choose when selecting a structure for their business. A sole proprietorship is an unincorporated entity that does not exist apart from its sole owner . A partnership is two or more people agreeing to operate a business for profit. A corporation is a legal entity -- a "person" in the eyes of the law -- existing separate and apart from its owners. Ease of formation, management, protection from personal liability and taxation are some factors business owners should consider in choosing a business structure.

Sole Propietorships

There are no formalities involved in creating a sole proprietorship that will operate under the owner's name, other than obtaining licenses or permits related to the trade or profession of the owner. For example, a plumber or electrician might have to obtain a license. An in-home day care provider might need to meet certain inspection requirements. A sole proprietor using fictitious name for the business must file an assumed name certificate with the state or local government. The sole proprietor has exclusive control over management decisions and operations, reports all profits and losses on her personal income tax return and is personally liable for business debts and obligations. When the sole proprietor dies or stops doing business, the company no longer exists.

General Partnerships

Two or more people agreeing verbally or in writing to operate a business for profit constitutes a general partnership. If a general partnership operates under a fictitious name, the partners must register it with the state or local government. Each partner has the right to participate in the management of the business and to share equally in profits and losses, however, partners may agree in writing to an unequal allocation of management control and profits and losses.

Partners and sole proprietors have the same exposure to personal liability. A creditor of the partnership sues the partners individually and, if successful, may collect from the personal assets of any or all of the partners. Also, like a sole proprietorship, each partner reports his share of business profits and losses on his personal tax return. Absent a partnership agreement that states otherwise, the partnership will end if one partner withdraws or dies.

Read More: General Partnership Vs. LLC

Limited Partnerships

A general partner signing a partnership agreement and filing a certificate of limited partnership with the state forms a limited partnership. Unlike a general partnership that has only one class of partners, limited partnerships have at least one general partner and one or more limited partners.

As in a general partnership, limited and general partners share profits and losses that they then report on their personal income tax returns. The advantage for a limited partner is that unlike general partners, a limited partner’s liability is restricted to the money she invested in the business and does not extend to her personal assets as long as she does not participate in management of the business.

Corporations

A corporation is created by filing articles of incorporation with the state in which the company will be doing business. The filed articles contain information about the new corporation including its street address, the number of shares of stock the corporation may issue and the type of business it will conduct. Corporations are owned by shareholders who do not participate in their management or operation, and instead elect a board of directors to handle management responsibilities. Officers, such as a president and vice-president, are appointed by the board to oversee day-to-day operations. It is common for a small corporation to have only one shareholder who is the sole officer and director.

Corporations are legal entities separate and apart from the shareholders, so they can sue and be sued in their own name. This protects the personal assets of the shareholders from liability for corporate obligations and debts. The death or withdrawal of a shareholder will not end the company's existence.

S Corporations

Corporations pay taxes on their profits. If they then distribute those profits to shareholders in the form of dividends, the shareholders pay taxes on that income as well. Corporations that meet certain IRS requirements, including having no more than 100 shareholders, can file for S corporation status which allows them to pass income and losses through to the shareholders, similar to a partnership, while allowing them the limited liability of a corporation.

Generally speaking, there are three ways to register a business in Ontario: sole proprietorship, partnership, or a corporation.

Sole proprietorship

A sole proprietorship business is operated by one person. The income is directly attributed to that person (the “Owner”) as “business income”. The business does not have a separate existence apart from the Owner. Revenue and expenses are included in the in the Owner’s income tax return, and the Owner is fully liable for all debts and obligations.

There is no separation between the Owner’s business assets and personal assets. In fact, if the business is operated under the full legal name of the Owner, it may not even be necessary to register a business name.  

Partnership

A partnership is a business operated by two or more people, “with a view to a profit”.

Partnerships can occur organically, without any paperwork and sometimes without the people even meaning to create one.

However, it is best practice to have a partnership agreement in place, and to set out the rights and responsibilities of the partners involved. This is especially important because the partnership does not have a separate legal existence apart from the partners – income is included in a partner’s personal income tax return, and the partners are all personally liable for debts (except in the case of a limited partnership – where there must be at least one general partner who is fully liable, and there may be other limited partners whose liability is limited). Each partner can bind the partnership, and a partner might be responsible for the actions of another partner.

Corporation

A corporation, on the other hand, has a separate legal existence from the people who own it.

A corporation, therefore, has separate tax filings, can change ownership, and has a continuous existence apart from the owners/shareholders. Because of its separate legal existence, a corporation can also shield the shareholders from personal liability – except in certain circumstances, a shareholder’s personal assets are protected from the liabilities of the corporation. On the other hand, corporations are closely regulated, and have higher start up and ongoing costs.   

People may choose to incorporate for any number of reasons including: collective ownership, succession planning, limited liability, tax advantages, and raising funds, to name a few.

If you choose to incorporate, you will need to file articles of incorporation and set out your shareholders, directors and officers. Shareholders are the owners of the corporation – they are the ones who are entitled to the profits of the business and must approve certain corporate changes. Directors are elected or appointed by the shareholders, and they, as a Board, manage the corporation and make business decisions. Officers are appointed by the directors and the directors define their duties and delegate tasks to them for the “day-to-day” operations of the business. It is possible for the same people to wear all three hats, and this is certainly the case for smaller businesses.

There are other considerations as well for new corporations, including banking, accounting or tax, borrowing, and, often, an agreement between shareholders to set out their rights and obligations. A “unanimous shareholders’ agreement” is an agreement signed by all shareholders, and confirmed by the corporation, that can deal with issues such as: restrictions on transfer of shares, mandatory buy/sell provisions upon death or default; required approvals for certain corporate actions; obligations on shareholders to fund the corporation; confidentiality and non-competition arrangements; etc.   

Deciding on a business structure is the first step to starting your new business – it is an important decision, and if it's done properly with appropriate legal advice, can save you time and money down the road.

Get in touch with one of our Business Law experts to learn more.

The content of this article is intended to provide a general guide to the subject matter and is not legal advice. Specialist advice should be sought regarding your specific circumstance.