Sole Proprietorships and General Partnerships

Choosing an organizational form for your business requires the consideration of many subjects unique to your operation.

If you are the sole owner of a business, and you have not formally created either a corporation or an LLC, you are operating a sole proprietorship. Sole proprietorships cannot themselves own any assets; therefore, all of the business assets will be considered your personal property. All of your assets--business and personal--are subject to the claims of all of your creditors--business and personal.

If you are a co-owner of a business, and you have not formally created a corporation, LLC, LLP, LP (or LLLP), you are operating a general partnership. Again, you have unlimited, personal liability for all of the businesses debts, including the acts of employees. In the case of the general partnership, you also have unlimited, personal liability for the acts of all of the other owners.

If you are already operating a business as a sole proprietorship or general partnership, you should seriously consider converting the business to an LLC or corporation. This simple change converts your liability from unlimited, personal liability for the business's debts to limited liability, and the conversion may be accomplished tax-free. In some cases, there may be a tax bill due upon the conversion of a general partnership to a corporation, so consult a tax professional first if you are considering this step.

The IRS will automatically treat a single-owner LLC as a sole proprietorship for tax purposes, so you would retain all the simplicity and tax savings of the simpler business form. Similarly, a multiple-owner LLC will be treated as if it were a partnership for tax purposes, so after a conversion you would continue to file a partnership tax return and retain the favorable pass-through tax treatment that goes along with partnership status. You can elect to forego the more favorable treatment and have your LLC taxed as a corporation, though this is rarely done.

Finally, what can you do to protect assets if you decide that you still want to operate in the form of the sole proprietorship? You must rely on other asset protection strategies discussed here, including post-judgment and bankruptcy asset exemptions, asset protection trusts, use of independent contractors, insurance, etc.

As for the small business owners who still want to operate in the form of a general partnership, here is some general advice: Don't do it. The general partner experiences all of the same exposures to liability as the sole proprietor, plus unlimited, personal liability for the acts of all of his co-owners. This should make even the biggest risk-taker reconsider that decision. It has been said that when the biggest accounting firms were operating as general partnerships, they relied on one asset protection strategy in particular: a whole lot of insurance. In fact, some commentators attribute the rapid, spectacular collapse of Arthur Andersen to the fact is was operating as a partnership. Today, all of the (remaining) major accounting firms are organized as LLPs, LLCs or corporations.

Small business partnerships should follow the lead of these firms. Remember that the costs of forming an LLC or corporation--your likely options--with more than one owner will be lower, as the costs will be shared by all of the owners.