What is a sole proprietorship?
Whether you already own a small business or are considering starting one, you may be curious about your business entity options and the advantages and disadvantages of each. In this post, I'll explore the sole proprietorship: what it is, how to form one, and its pros and cons.
Sole proprietorship defined
A sole proprietorship is an unincorporated business entity owned by one person. The business is identified with and entwined with you. In other words, there is no legal distinction between you and your business.
Thus, when your business makes a profit, it's your profit. When your business incurs a debt, it is your debt. And when someone sues your business, that someone sues you.
How to form a sole proprietorship
A sole proprietorship is the most accessible business entity you can form. Since you and your business are legally indistinguishable, there aren't any formalities you must follow to create it. You announce to the world that you’re in business with the intent to make a profit, and presto, you're a sole proprietor. And you remain a business as long as you call yourself a business.
Nevertheless, there are a few formalities you must follow to operate it.
For example:
You must register a d/b/a, a/b/n, or fictitious name statement in the county or state where you run your business if your business name is not the same as your name.
You need a sales tax permit if you sell products or services subject to sales tax.
You need an (EIN) Federal Employer Identification Number if you have employees.
You may be subject to certain zoning restrictions if you work from home.
You may need a business license or permit if you work from home and deal with the public.
Advantages of a sole proprietorship
Easy and inexpensive to form. A sole proprietorship is the least regulated business entity. As such, there are no forms to fill out or fees to pay to establish your business legally. Just say that you're open for business, and you are!
Simple tax treatment. Because there are no business income tax returns to file, there is no concern with complex bookkeeping or double taxation. You report your business income and expenses on IRS Schedules C and SE with IRS Form 1040.
Few compliance formalities. When it comes to maintaining your business as a sole proprietor, there is very little to worry about: there are no corporate records to maintain, no meetings to hold, no minutes to keep, no resolutions to draft, and no annual reports to file.
Disadvantages of a sole proprietorship
Unlimited personal liability. You are personally liable for all business debts, liabilities, obligations, and taxes. You can lose your assets to satisfy a business judgment. Furthermore, if you have employees, you are personally responsible for any legal claim against your employee when they act within the course and scope of their employment.
Fewer tax reduction opportunities. Because of the simple tax treatment, fewer tax reduction strategies are available. The result: you may pay higher taxes than you need to. As a sole proprietor, you cannot take advantage of special business income tax rates or deductions.
Difficulty obtaining capital. Whether it's finding human capital or financial capital, finding much-needed resources for a sole proprietorship can be challenging.
