If you have more than one person owning your business, you can choose to form a partnership.

Partnerships can be informal but that’s not usually a good idea. Especially if your partner is a friend or relative — I’ve seen so many of these go bust that I can tell you definitively that you must have a partnership agreement that covers such things as compensation, time commitments of the partners, how you will divide profits and losses, how capital contributions will be made and by whom, as well as, most importantly of all, how one gets out of the partnership and what happens when that occurs. A sample of a partnership agreement can be found here, as well as many other places on the web. Be sure to consult a legal professional and a tax professional before you sign any partnership agreement.

Partnerships file Form 1065 for Federal tax purposes. The question often comes up as to whether a husband-and-wife partnership needs to file Form 1065; according to the IRS, the answer is yes — although there is some question as to whether, in community property states, the couple could just split the partnership return numbers down the middle and report two Schedule C’s with Form 1040.

When you file a Form 1065, you will also take the results of that form, and issue Form K-1 to each of the partners. This will include such information as the partners’ share of income or loss, depreciation, Section 179 “instant” depreciation, and other information which is then used by each partner on Schedule E of their personal Form 1040s.

While partnerships are not liable for income taxes, they do pass along their income or loss to the partners on Form K1 — so that we avoid the “double taxation” inherent in a C-Corporation (see the post on C Corps once we release it).

Advantages of Partnerships

1. Not subject to income taxation. As mentioned above, profits and losses are allocated to the partners for reporting on their own individual tax returns via Schedule E.

2. Simple to set up — All you basically need in most jurisdictions is to file a ficticious name statement or the equivelent with the local authorities. It is very advisable, however, to have a thorough partnership agreement signed by all the partners — althoug this doesn’t have to necessarily be filed with any government agency.

Disadvantages

1. Does not convey liability protection to the owners. A general partnership has general liability. Each of the partners is responsible for the debts, actions, and other liabilities of the partnership. Some of this can be mitigated by correct insurance, but the bottom line is, there’s no “line of defence” of the sort that limited liability companies or corporations have.

2. In the absence of a good partnership agreement, it can be difficult to get out (or get someone out) of a partnership.

3. As in item 1., the business actions of any partner bind all the partners. So you’d better be very sure that you’re going to like the decisions of your partners, or have agreements in place to handle such problems that might come up. Any partner can bind the partnership to contracts, or the ramifications of their actions regarding the business.

Generally, it’s our opinion that other than the case of a married couple, general partnerships aren’t going to be the way to go for bloggers or web commerce businesses. If you have more than one owner who are not married, you will want to consider either a limited liability company (LLC) or a corporation.

When you first start out in business, you often don’t think about things like choosing a business entity.

The very act of not choosing an entity (ie being a “sole proprietor” is making such a choice. And it’s important that you understand what you decide can make a big difference on how you are taxed, your personal liability in the business, and more.

There are a number of forms of entity that you can use for your blogging business. We’ll start with the simplest, cheapest, and most problematic form.

Sole proprietor

Sole proprietors run their businesses as an extension of themselves, even if they have a name for the business, etc. If you do have a business name different from your own, be sure that you are following your local laws regarding filing fictitious business names (or “DBA”). That being said, a sole proprietor reports their income and expenses, usually, on Schedule C. This is an additional form that you submit with your 1040 form to the IRS.

Advantages of being a sole proprietor include:

1. Simplicity — you don’t have to file forms with the state, or IRS, to become a sole propietor.

2. Lower costs — you don’t have to file separate tax returns for your entity; it’s all on Schedule C.

3. Lower taxes — almost all states charge a minimum tax for a corporation or LLC to operate in their state; all the hoopla about “saving taxes by incorporating in Nevada”, for a lot of people, is just that — if you live in California, for example, your “Nevada corporation” is still subject to the tax laws of California including the minimum taxes.

Disadvantages

1. There’s often a tendency of sole proprietors to not separate their business income and expenses from their ordinary income and expenses. Sloppy record-keeping is a danger to all businesses, but it’s more prevalent among sole proprietors. The IRS realizes this, and in our experience, they are more likely to examine Schedule C filers than those who form corporations or other entities that are required under state law to keep a general ledger and other official records.

2. You cannot easily expand the business to include other people. People who invest in your business will want to be issued shares, or enter into partnership agreements with you. If you are thinking of some day expanding the ownership of your company, you’ll need to set up a new entity.

3. Legal liability — a sole proprietor is legally liable for everything they do. Debts, libel, accidents and more can expose the sole proprietor to personal liability. While another form of entity doesn’t necessarily eliminate or reduce liability, it can be useful.