How Sole Proprietorship Works

When I first started working from home as a self-employed person, I was a sole proprietorship (I’ve since changed my organizational structure to a LLC, though). For entrepreneurs, it is probably the easiest type of business structure to set because you don’t actually have to do anything beyond providing goods or services for a price, except may register your business with your state.

You and Your Sole Proprietorship

When your business is set up as a sole proprietorship, you are indistinguishable from your company. You are liable for whatever debts or legal actions are taken against your company. Even if you have a separate business account, you, personally, are still considered liable for what goes on with the sole proprietorship. It is important to understand this. If you are considered about possible accidents resulting in injuries, or other issues of financial liability, you might consider another business structure.

Sole Proprietorship and Taxation

Because you and your sole proprietorship are one and the same, you are taxed as a single entity as well. This simplifies your tax preparation quite, since your business income is taxed as part of your personal income. However, you do need to be aware that you need to fill out a Schedule C when filing your taxes. The Schedule C is a record of your profits and losses from business activities. Once it is completed, the final amount from the Schedule C is added to what’s on your Form 1040. You will also have to use a Schedule SE to figure your self-employment tax. However, you do not need to fill out K-1 forms or keep payroll records as part of your tax package. It is recommended, however, that you purchase an up-to-date tax software program to ensure accuracy and help maximize your returns when you are ready to file.

Main Advantages of a Sole Proprietorship

As you might expect, the main advantage of a sole proprietorship is the ease of its formation. You can form a sole proprietorship immediately, and call it what you want (watch out for trademark issues, though), without ever having to file organizational paperwork, although some states require that you register as a business. Other advantages include:

• Beyond renewing state business registration in some areas, there are no ongoing formalities to the structure.
• You can mix your personal assets with your business assets.
• While you have to pay unemployment tax on employees, you do not have to pay it on yourself.
• Keeping financial records is straightforward and simple, although you will need to keep track of business income and expenses for your Schedule C.

Main Disadvantages of a Sole Proprietorship

The biggest issue with a sole proprietorship is that of liability. If you plan to hire other workers, or if people visit your place of business, this could be a problem when it comes to injury liability, since your personal assets are game for lawsuits, even if the complaint is against the business. Other disadvantages of a sole proprietorship include:

• Difficulty retaining value, since a sole proprietorship rarely survives its owner.
• Can’t sell interest in the business to raise capital.
• Sometimes difficult to properly separate business from personal when it comes to money matters.

Bottom line: For some, a sole proprietorship is a good idea. However, others might be better off deciding on a different organization that offers fewer liability risks. Figure out your current and future needs, and how money is likely to work in your business, and make a decision based on what best fits your needs.