S Corp Vs. Partnership
Choosing the right structure for a new business ranks among the most important decisions faced by a fledgling business owner. Sole proprietorship, partnership and incorporation all have an impact on topics ranging from taxation and profit sharing to business management and legal protections. In the case of a small business venture that includes two or more partners, the choice is often between drafting a partnership agreement or incorporating as an S corporation.
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Partnership Types
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The Small Business Administration advises that partnerships may exist as general partnerships, limited or limited-liability partnerships, or as joint ventures. General partnerships are the simplest form of partnership to begin, as they may be created with nothing more than an oral agreement. Limited or limited-liability partnerships may offer some legal protections for partners and take an officially structured form but are more costly and complicated to start and maintain. Joint ventures are typically used for time or project-based partnerships but may be difficult and costly to create and dissolve, when the time comes.
Incorporation and Subchapter S Corporations
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Legal protections and potential tax benefits stand among the top reasons to incorporate, and many small businesses opt to form as a special type of corporation known as a subchapter S corporation to enhance these benefits. The costs of incorporating are often much higher compared to creating a partnership, however, and corporations face several ongoing fees, regulations and operating costs that most partnerships can avoid. Certain restrictions must also be met to form an S corporation, including the number and nationality of shareholders.
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Regulations and Licensing
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While partnerships may require the traditional business licensing needed to operate, S corporations face many more regulatory and licensing obstacles, including licenses and fees needed to simply exist. Some states do not recognize the tax benefits of a S corporation or require additional filings and registrations before providing them. This alone may generate extra legal and accounting fees before obtaining the full benefits of an S corporation.
Revenue and Profit Sharing
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Money earned through a partnership is often shared equally among all partners, even if one or more of the partners has contributed less. Although this may be overcome through a well-designed partnership agreement, the additional costs and potential for legal dispute may not be worthwhile.
S corporations, alternatively, have a built-in mechanism for a relative distribution of profit in the form of shares of stock, with shareholders receiving a portion of distributions based on the number and type of shares owned, individually.
Management
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Management considerations are sometimes dramatically different between a partnership and an S corporation. Foremost among these considerations is the shared fiduciary duty of a partner to all other partners, collectively. A failure by one partner to uphold his fiduciary duty can result in dissolution of the partnership or cause complicated legal and personal disputes.
In a corporation, a lawsuit over lapses in fiduciary duty may not mean the end of the corporation, presuming it can withstand the financial burdens that such a lawsuit may bring. Directors and officers may be replaced in a corporation, however, and legal protections for shareholders against lawsuits of any kind are substantially greater than the protections found for partners in a partnership.
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