When there is more than one participant, you can’t be a sole proprietor. That goes for husband and wife also, except in some special circumstances. Like a sole proprietorship, a partnership is easy to form and without a lot of red tape. You do need an agreement, which also makes good business sense! The biggest downside is that you have unlimited liability not only for your actions, but for the actions of the other partners.
Partnerships are not taxed, but do have their own informational tax return — a form 1065. The form 1065 reports the income and expenses for the partnership and divides the items among the partners based on the partnership agreement. Each partner is given a K-1 with his/her share of the income/loss to be reported on various lines of their individual tax return. The form 1065 can be quite complicated and should be prepared by a qualified tax preparer — another expense. Partners pay self-employment tax on the income rather than being employees with a W-2.
Fringe benefits are generally not deductible for partners, and the options for fringe benefits and retirement plans are much the same as for sole-proprietors.
A partnership interest can be transferred and continue after the demise of a partner depending on the partnership agreement. Also, if an LLC is comprised of more than one member, a partnership is the default entity if no other choice is made. More about this when we get to LLCs.