Definition: A business that legally has no separate existence from its owner.
Income and losses are taxed on the individual's personal income tax
return.
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The sole proprietorship is the simplest business form under
which one can operate a business.
The sole proprietorship is not a
legal entity. It simply refers to a person who owns the business
and is personally responsible for its debts.
A sole proprietorship
can operate under the name of its owner or it can do business under
a fictitious name, such as Nancy's Nail Salon. The fictitious name
is simply a trade name--it does not create a legal entity separate
from the sole proprietor owner.
The sole proprietorship is a popular business form due to its
simplicity, ease of setup, and nominal cost. A sole proprietor need
only register his or her name and secure local licenses, and the
sole proprietor is ready for business. A distinct disadvantage,
however, is that the owner of a sole proprietorship remains
personally liable for all the business's debts. So, if a sole
proprietor business runs into financial trouble, creditors can
bring lawsuits against the business owner. If such suits are
successful, the owner will have to pay the business debts with his
or her own money.
The owner of a sole proprietorship typically signs contracts in
his or her own name, because the sole proprietorship has no
separate identity under the law. The sole proprietor owner will
typically have customers write checks in the owner's name, even if
the business uses a fictitious name. Sole proprietor owners can,
and often do, commingle personal and business property and funds,
something that partnerships, LLCs and corporations cannot do.
Sole
proprietorships often have their bank accounts in the name of the
owner.
Sole proprietors need not observe formalities such as voting
and meetings associated with the more complex business forms.
Sole
proprietorships can bring lawsuits (and can be sued) using the name
of the sole proprietor owner. Many businesses begin as sole
proprietorships and graduate to more complex business forms as the
business develops.
Because a sole proprietorship is indistinguishable from its
owner, sole proprietorship taxation is quite simple. The income
earned by a sole proprietorship is income earned by its owner.
A
sole proprietor reports the sole proprietorship income and/or
losses and expenses by filling out and filing a Schedule C, along
with the standard Form 1040. Your profits and losses are first
recorded on a tax form called Schedule C, which is filed along with
your 1040. Then the "bottom-line amount" from Schedule C is
transferred to your personal tax return. This aspect is attractive
because business losses you suffer may offset income earned from
other sources.
As a sole proprietor, you must also file a Schedule SE with Form
1040. You use Schedule SE to calculate how much self-employment tax
you owe. You need not pay unemployment tax on yourself, although
you must pay unemployment tax on any employees of the business. Of
course, you won't enjoy unemployment benefits should the business
suffer.
Sole proprietors are personally liable for all debts of a sole
proprietorship business. Let's examine this more closely because
the potential liability can be alarming. Assume that a sole
proprietor borrows money to operate but the business loses its
major customer, goes out of business, and is unable to repay the
loan. The sole proprietor is liable for the amount of the loan,
which can potentially consume all her personal assets.
Imagine an even worse scenario: The sole proprietor (or even one
her employees) is involved in a business-related accident in which
someone is injured or killed. The resulting negligence case can be
brought against the sole proprietor owner and against her personal
assets, such as her bank account, her retirement accounts, and even
her home.
Consider the preceding paragraphs carefully before selecting a
sole proprietorship as your business form. Accidents do happen, and
businesses go out of business all the time. Any sole proprietorship
that suffers such an unfortunate circumstance is likely to quickly
become a nightmare for its owner.
If a sole proprietor is wronged by another party, he can bring a
lawsuit in his own name. Conversely, if a corporation or LLC is
wronged by another party, the entity must bring its claim under the
name of the company.
The advantages of a sole proprietorship include:
- Owners can establish a sole proprietorship
instantly, easily and inexpensively.
- Sole proprietorships carry little, if any, ongoing
formalities.
- A sole proprietor need not pay unemployment tax on
himself or herself (although he or she must pay unemployment tax on
employees).
- Owners may freely mix business or personal
assets.
The disadvantages of a sole proprietorship include:
- Owners are subject to unlimited personal liability
for the debts, losses and liabilities of the business.
- Owners cannot raise capital by selling an interest
in the business.
- Sole proprietorships rarely survive the death or
incapacity of their owners and so do not retain value.
One of the great features of a sole proprietorship is the
simplicity of formation. Little more than buying and selling goods
or services is needed. In fact, no formal filing or event is
required to form a sole proprietorship; it is a status that arises
automatically from one's business activity.
