Are You a Sole Proprietor?

Want to run your biz as a sole proprietorship? Get hip to pros and cons, tax issues, and your legal liabilities.

The sole proprietorship is the simplest business form underwhich one can operate a business. The sole proprietorship is not alegal entity. It simply refers to a person who owns the businessand is personally responsible for its debts. A sole proprietorshipcan operate under the name of its owner or it can do business undera fictitious name, such as Nancy's Nail Salon. The fictitiousname is simply a trade name--it does not create a legal entityseparate from the sole proprietor owner.

The sole proprietorship is a popular business form due to itssimplicity, ease of setup, and nominal cost. A sole proprietor needonly register his or her name and secure local licenses, and thesole proprietor is ready for business. A distinct disadvantage,however, is that the owner of a sole proprietorship remainspersonally liable for all the business's debts. So, if a soleproprietor business runs into financial trouble, creditors canbring lawsuits against the business owner. If such suits aresuccessful, the owner will have to pay the business debts with hisor her own money.

The owner of a sole proprietorship typically signs contracts inhis or her own name, because the sole proprietorship has noseparate identity under the law. The sole proprietor owner willtypically have customers write checks in the owner's name, evenif 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. Soleproprietorships often have their bank accounts in the name of theowner. Sole proprietors need not observe formalities such as votingand meetings associated with the more complex business forms. Soleproprietorships can bring lawsuits (and can be sued) using the nameof the sole proprietor owner. Many businesses begin as soleproprietorships and graduate to more complex business forms as thebusiness develops.

Tax Implications

Because a sole proprietorship is indistinguishable from itsowner, sole proprietorship taxation is quite simple. The incomeearned by a sole proprietorship is income earned by its owner. Asole proprietor reports the sole proprietorship income and/orlosses and expenses by filling out and filing a Schedule C, alongwith the standard Form 1040. Your profits and losses are firstrecorded on a tax form called Schedule C, which is filed along withyour 1040. Then the "bottom-line amount" from Schedule Cis transferred to your personal tax return. This aspect isattractive because business losses you suffer may offset incomeearned from other sources.

As a sole proprietor, you must also file a Schedule SE with Form1040. You use Schedule SE to calculate how much self-employment taxyou owe. You need not pay unemployment tax on yourself, althoughyou must pay unemployment tax on any employees of the business. Ofcourse, you won't enjoy unemployment benefits should thebusiness suffer.

Suing and Being Sued

Sole proprietors are personally liable for all debts of a soleproprietorship business. Let's examine this more closelybecause the potential liability can be alarming. Assume that a soleproprietor borrows money to operate but the business loses itsmajor customer, goes out of business, and is unable to repay theloan. 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 oneher employees) is involved in a business-related accident in whichsomeone is injured or killed. The resulting negligence case can bebrought against the sole proprietor owner and against her personalassets, such as her bank account, her retirement accounts, and evenher home.

Considering the preceding paragraphs carefully before selectinga sole proprietorship as your business form. Accidents do happen,and businesses go out of business all the time. Any soleproprietorship that suffers such an unfortunate circumstance islikely to quickly become a nightmare for its owner.

If a sole proprietor is wronged by another party, he can bring alawsuit in his own name. Conversely, if a corporation or LLC iswronged by another party, the entity must bring its claim under thename of the company.

Advantages of a Sole Proprietorship

  • Owners can establish a sole proprietorship instantly, easilyand inexpensively.
  • Sole proprietorships carry little, if any, ongoingformalities.
  • A sole proprietor need not pay unemployment tax on himself orherself (although he or she must pay unemployment tax onemployees).
  • Owners may freely mix business or personal assets.

Disadvantages of a Sole Proprietorship

  • Owners are subject to unlimited personal liability for thedebts, losses and liabilities of the business.
  • Owners cannot raise capital by selling an interest in thebusiness.
  • Sole proprietorships rarely survive the death or incapacity oftheir owners and so do not retain value.

Forming a Sole Proprietorship

You may already be operating a sole proprietorship. One of thegreat features of a sole proprietorship is the simplicity offormation. Little more than buying and selling goods or services isneeded. In fact, no formal filing or event is required to form asole proprietorship; it is a status that arises automatically fromone's business activity.

This article was excerpted from the books Start Your OwnBusiness and Entrepreneur Magazine's Ultimate Book onForming Corporations, LLC's, Sole Proprietorships andPartnerships.

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