Sole Proprietorship: The Pros and Cons

A sole proprietorship is a form of business structure that is run by a single person or one individual.

In this form, the owner is the business (not a separate entity) and owns all the assets of the business and the profits generated by it. They also assume complete responsibility for any of its liabilities or debts.

If you start a business right now by yourself, you are considered a sole proprietorship by default. There is really nothing else to do except filing a business license, permits, doing business as (DBA), which are required for all forms of businesses depending on the city or county laws.

The one distinct feature of a sole proprietorship is that in the eyes of the law, the business and yourself are considered one and the same. Thus, all the earnings of the business are treated as your personal earnings.

However, if the business defaulted on loans or get sued, creditors can come after your personal assets if the obligations and claims are not satisfied by the business.

What are the Advantages:

  • Easy to Form – The simplest form of business structure since it offers the least paperwork required to file compared to other forms of business. Corporation and LLCs have to file documents to the state while partnership may require partnership agreements to begin with.
  • Least Expensive Form – It is the least expensive to form since it does not have the extra document filing cost associated with the state entities.
  • Fewer Government Regulations – It is also subject to fewer government regulations compared to other forms of business
  • Complete Control – Sole proprietors are in complete control and are responsible for all the decisions of the company.
  • 100% Allocation of Income – The sole proprietors receive all income generated by the business unlike other forms of business where earning will be allocated depending on their ownership interest in the company.
  • No double taxation – All profits from the business flow directly to the owner’s personal tax return, thus, are only taxed once.
  • Easy to terminate – The business is easy to terminate since you do not have to file extra documents to dissolve the business that are normally applied to corporations and LLCs.
  • Much Simpler Tax Issues – the tax issues on the sole proprietorship are much simpler when compared to other forms of business.

What are the Disadvantages:

  • Unlimited Liability – Sole proprietors have unlimited personal liability and are legally responsible for all debts against the business. Creditors can go after both the business and personal assets of the sole proprietors to satisfy the business debts. Or in the case of a lawsuit, you are also personally responsible for any claims and judgments against your business.
  • Limited Capital Funding – In raising capital, the owner is limited to using funds from personal savings or consumer loans unlike other forms of business where another person or investor provides additional capital.
  • Lack of business continuity – When the owner dies, so does the business.
  • Unable to attract high-caliber employees – May have a hard time attracting high-caliber employees or those that are motivated by the opportunity to own a part of the business.
  • Payment of Self-employment tax – Sole proprietorship benefits on single level of taxation but it has to pay another form of tax called self-employment tax. Dividends of the corporations distributed to the owners are not subject to self-employment tax.

Is a sole proprietorship right for you?

If you are the type of person who:

  • Likes to control things by themselves
  • Wants to start immediately without all the headaches of state regulations present with corporations and LLC’s
  • Does not want the annual reporting requirements associated with corporations, LLC, etc.
  • Does not want to pay taxes twice on the profits or the minimum tax liability as required by some state
  • Wants 100% of the profits for themselves

Then a sole proprietorship may be a good option.

Most Common Federal Tax Forms for Sole Proprietorship

  • Form 1040: Individual Income Tax Return
  • Schedule C: Profit or Loss from Business (or Schedule C-EZ)
  • Schedule SE: Self-Employment Tax
  • Form 1040-ES: Estimated Tax for Individuals
  • Form 8829: Expenses for Business Use of your Home

Source: sba.gov, irs.gov