The Sole Proprietorship: An Overview

The sole proprietorship is the simplest and least regulated of all business entity structures (e.g. corporation, LLC, general partnership, etc.). For legal and tax purposes, the sole proprietorship’s owner is the business. The liabilities of the business are personal to the owner and the business ends when the owner dies. On the other hand, all of the profits are also personal to the owner and the sole owner has full control of the business.

Disadvantages

The primary consideration in choosing this type of business structure is liability. With a sole proprietorship, you have no asset protection. With just one lawsuit against the business, your house, savings and personal assets can be lost. If the demands of the business’ creditors exceed those assets which were formally placed in the name of the business, the creditors can tap the owner’s personal assets. This unlimited liability is a significant drawback to the sole proprietorship.

Depending on the profitability of the business, a sole proprietorship may incur a larger tax liability than other business structures. Profit from a sole proprietorship is reported on Schedule C of the owner’s personal income tax return, and is subject to self-employment tax (the “employer’s match” of Social Security and Medicare taxes). You are taxed on all profits in the year they are earned, whether or not you actually take money out of the business. When you reinvest in your sole proprietorship business, you must do so with “after tax” money. Additionally, certain fringe benefit plans are not tax-deductible to the sole proprietor.

Sole proprietorships also face potential difficulty in obtaining business loans. Often in starting a small business, there is insufficient collateral to obtain a loan and the sole owner must use his own personal assets as collateral to obtain the loan. This, of course, puts the owner’s personal assets in a direct position of risk should the business fail.

The sole proprietorship suffers from the lack of continuity that is inherent in the business form. It is difficult to sell a sole proprietorship, since its value is based on the owner and not the business. Upon the owner’s death, the assets of the sole proprietorship become part of the estate, and may face estate tax and probate consequences.

Advantages

The sole proprietorship is the simplest of all business structures. Aside from the maintenance of records for tax purposes, this type of business is not subject to legal requirements for how it must be operated (e.g. annual documentation and filings with the Secretary of State).