There are no mandatory reporting requirements for sole proprietorships like there are for corporations or partnerships. You don’t need to file any special documents with your state government to form one as long as you don’t plan on hiring anyone but yourself as an employee, partner or independent contractor. A sole proprietorship has significant advantages over other business types, especially if you’re working on your own and can take complete control of your operations:
Protection for the owner’s personal assets.
A proprietorship firm registration is a completely separate legal entity from the owner. If you start a sole proprietorship, your business assets and the owner’s personal assets are completely separate. Your business might fail, but that won’t affect your personal assets. Your personal assets will remain out of reach of your creditors and other people who may have a claim against your business. And vice versa. If you are held personally liable for business-related debts and obligations, your personal assets will be at risk. Any debts and obligations of the business will be your personal responsibility. For example, if you sign a contract to do work for a client and then your business goes bankrupt and can’t pay the client, you’ll be on the hook for that debt.
Tax benefits.
Since your business and personal assets are legally separate, a sole proprietorship is an “intentionally flawed entity” for tax purposes. That means you can use the sole proprietorship’s tax status to reduce your taxes. In the U.S., there are no self-employment taxes or employment insurance premiums on behalf of the owner. Other taxes may apply, such as sales tax on goods sold and income tax on any profits generated, but those are the same taxes imposed on a business incorporated as a corporation.
Easy to start, operate and exit.
All you need to do is start working. There’s no need to file articles of incorporation, hold an annual meeting or keep minutes of an annual shareholders’ meeting. When you’re ready to shut down your sole proprietorship, there’s no need to dissolve the business, sell it or transfer the assets to someone else. All you have to do is stop working. There’s no need to go to a state government office to terminate the business or file any special paperwork.
No employees means no payroll taxes or employment insurance premiums.
As long as you work alone, there are no employment taxes to pay. Sole proprietorships don’t have to withhold income taxes from their owner’s pay or pay federal and state employment taxes on behalf of the owner. There’s no need to pay any benefits to yourself, such as a 401(k) contribution or health insurance premiums. There’s no need for the owner to file a W-2 form or issue a 1099 form to report annual earnings to the Internal Revenue Service. There’s no need for the owner to maintain benefits records, keep workers’ compensation insurance or pay workers’ compensation premiums. Workers’ compensation is an insurance policy for employees that covers medical care and lost wages when an employee suffers a work-related injury that costs time away from the job.
Disadvantages of a Sole Proprietorship
Although the legal protections provided by a sole proprietorship are significant, they’re not without costs. All the benefits of a sole proprietorship come at a price. As a sole proprietor, you’ll have to pay self-employment taxes on your income, which will reduce any profits you generate. And there’s no way to avoid paying taxes on the income you earn. You can’t use a sole proprietorship to completely avoid taxes. And there’s no guarantee a government agency will accept your name as the legal name of your business. In fact, many state agencies require sole proprietors to use their owner’s name. There’s no guarantee a bank or other lender will accept your business as an unincorporated entity. Some lenders are willing to provide financing based on an unincorporated business, but others require you to form a corporation or limited liability company (LLC) to secure a loan.
How to Form a Sole Proprietorship
A sole proprietorship is the easiest business to form. All you have to do is start working. There’s no need to file any special paperwork with a state government office. You don’t have to file articles of incorporation, hold an annual meeting or keep minutes of an annual shareholders’ meeting. All you have to do is start working. If you want to form a sole proprietorship and you don’t want to incorporate, the easiest thing to do is go ahead and start working. Get a bank account in your name, get a credit card in your name and get a cellphone plan in your name. Get everything in your name that you’d get if you had incorporated. That includes getting a license and local tax ID number, if applicable.
The Disadvantages of a Sole Proprietorship
As a sole proprietor, you’re personally liable for all business-related debts and obligations. You’ll be held legally responsible if your business is sued or if one of your customers or clients sues you. If you’re held personally liable and lose the suit, the judgment may be satisfied by seizing your assets or obtaining a court order to garnish your wages. If you sign a contract to do work and then your business goes bankrupt and can’t pay the debt, you may have to pay the debt out of your own pocket. If your business has a contract to provide goods or services to a third party, the other party may seek to hold you personally liable for the debt.
4 Key Takeaways
A sole proprietorship is the simplest and least expensive business structure to form. Benefits of a sole proprietorship include protection for the owner’s personal assets, tax benefits, easy to start up and operate, and no employees means no payroll taxes or employment insurance premiums. Disadvantages of a sole proprietorship include being held personally liable for all business-related debts and obligations, and no guarantee a government agency will accept your name as the legal name of your business. Sole proprietorships have significant advantages over other business types, especially if you’re working on your own and can take complete control of your operations.
