What Is It?
A sole proprietorship is a form for conducting business by a single person as an owner. The owner is often referred to as a “sole proprietor” or a “proprietor”. A proprietor is may conduct business in his legal name, a non-deceptive assumed name, or a trade name. For example, John Smith could conduct business as “John Smith”, “John Smith’s Furniture Store” or “Excellent Furniture”. The defining legal aspect of a sole proprietorship is that there is no distinction between the business and the proprietor.
Although a sole proprietorship can have only one owner, sole proprietorships may have an unlimited number of employees and independent contractors.
Consequences of Doing Business as a Sole Proprietorship
Because there is no distinction between the business and the proprietor, (i) all business profits or losses accrue to the owner directly as income (subject to ordinary income taxes) or loss and (ii) any debts or other obligations owed by the business are debts and obligations of the proprietor. All financing is also done in the name of both the business and proprietor. The owner’s personal assets (including his house, bank accounts and personal assets) are at risk to pay the debts and other obligations of the business.
Taxation of a Sole Proprietorship
A proprietor simply declares any and all income or losses from operation of the business on her IRS Form 1040 income tax return by filling out either Schedule C or, if eligible, Schedule C-EZ). Because a proprietor is “self-employed,” a proprietor is responsible for paying both the employer and employee portions of contributions to Social Security and Medicare. The proprietor is taxed for income tax purpose for both her income derived from the business and other sources at her personal income tax rate.
Creating a Sole Proprietorship
Few formalities are required to create a sole proprietorship. Although specific rules vary from state to state, customarily the creation of a sole proprietorship does not require the filing of any documents with a secretary of state or paying any registration fees. If the business is conducted in an assumed name or trade name, the proprietor may need to publish the assume name or trade name together with the proprietor’s name in a newspaper of general circulation. The proprietor may need to register the business in the county in which the business is conducted. Additionally, states, counties, and other government subdivisions may require additional registrations and taxes of all new businesses.
Sole proprietorships without employees are not required to file any additional paperwork to register with the Internal Revenue Service. A sole proprietorship with one or more employees, should obtain an employer identification number from the Internal Revenue Service using IRS Form SS-4.
Advantages of a Sole Proprietorship
Operating a business as a sole proprietorship has several potential advantages, including:
- Easy to Start: The sole proprietorship is subject to few regulations, formalities, fees, or reporting requirements.
- Complete Control: The owner has complete decision making authority.
- Avoids Corporate Taxation: The sole proprietor is subject only to personal income tax. No separate income tax is imposed on the business itself.
- Full Deductibility of Business Losses: Business losses can be deducted against a proprietor’s (or her spouse’s) other income.
- Easy to End: If desired, dissolution of a sole proprietorship is fairly easy; although, the proprietor’s personal assets remain at risk.
Disadvantages of a Sole Proprietorship
There are disadvantages to doing business as a sole proprietorship. Chief among these are:
- Unlimited Personal Liability: The proprietor is personally liable for the debts and other obligations of the business. This personal liable survives the dissolution or other winding up of the business.
- Loss of Insurance Deduction: The sole proprietorship is not allowed to deduct costs related to employee health care coverage. Employees are not required to declare the value of an employer provided health insurance policy as income.
- Obstacles to Sale: The only method of selling a sole proprietorship is to transfer title of the businesses assets.
- Negative Consequences of Changing Forms: A sole proprietorship that later converts to a limited liability company or corporation may face negative tax consequences.
Most lawyers would not recommend doing business as a sole proprietorship other than for the least risky businesses, such as a street ice cream vendor. Why? Because the owner’s personal assets are at risk for business activities. The preferred form of doing business is as either a single shareholder corporation making a subchapter S election or single member limited liability company.
Legal Disclaimer
This website provides information addressing legal topics of interest to the general reader. You should not consider this information designed or adequate to meet any of your particular legal needs, concerns or inquiries. You should consult with a lawyer licensed to practice law in the jurisdiction appropriate to your legal situation to assess your situation and provide you with appropriate legal advice.