Sole Proprietorships

The sole proprietorship is the simplest and most common form of business entity. A sole proprietorship is a business that is conducted by a single individual owner (the “sole proprietor”). Sole proprietors can conduct business under their own name by simply doing business, for example, as “Jane Jones.” A sole proprietor can also do business under a trade name (sometimes called a “fictitious name”) as “Jane’s Jet Skis” or “Supreme Skis.” If a sole proprietor operates under a trade name or fictitious name, the sole proprietor is usually required to file a form (a “trade name certificate”) in the city, county, or state where the business is located. A sole proprietorship may have employees and is permitted to carry on most businesses.

Advantages

• A sole proprietorship is simple to start and avoids the operating expenses required for other legal entities such as corporations. For example, additional operating expenses for other forms of business may include incorporation expenses, franchise taxes, annual report fees, and additional professional fees. This is because the complex statutes governing partnerships, corporations and other kinds of business entities usually do not apply to or include sole proprietorships.
• Sole proprietors make their own decisions and avoid the conflicts that may occur among partners of a partnership or shareholders of a corporation.

Disadvantages

• Because a sole proprietorship is simply a single individual carrying on a business, the individual owner is personally liable for all the debts and other obligations of the business.
• It is usually difficult to obtain outside financing for a sole proprietorship. In making a decision to extend credit, a bank or other finance source will look at the net worth and individual credit history of the sole proprietor.
• Raising capital to start or expand the business is limited, as a practical matter, to what is called “debt financing” (that is, loans). This is because a sole proprietorship has only one owner and, as a result, cannot sell “equity interests” (stock or partnership interests) as is typically done by corporations and other forms of business.
• A sole proprietorship is a greater financial risk for the business owner. The sole proprietor is personally liable for all obligations of the business, including debts incurred in the operation of the business. The liabilities of a sole proprietor include liability for the negligent or willful acts of employees and agents. Thus, if an employee were to negligently injure a third person in the course of the employee’s duties, the sole proprietor may, along with the employee, be personally liable for damages. If the sole proprietor had no insurance or insufficient insurance to cover the damages, the sole proprietor’s other assets (home, car, or stock portfolio) could be seized to pay the damages.
• If the business is unsuccessful and is terminated, the sole proprietor will be personally liable for payment of all business debts such as bank loans and unpaid bills to vendors and service providers (accountants, consultants and attorneys). If the assets of the sole proprietor are insufficient to satisfy the outstanding business debts, the sole proprietor may be forced to declare personal bankruptcy.
• Legally, a sole proprietorship is totally identified with the sole proprietor. Therefore, on the death of the owner, the business enterprise terminates, leaving only the assets of the business such as equipment, accounts receivable, and real property. Because the assets used in the business are not separated from the other assets of the sole proprietor, it may be difficult to sell the business as a whole after the death of the sole proprietor. If there are disputes among the heirs, selling the business assets can be particularly troublesome.

Tax treatment of Sole Proprietorships

A sole proprietorship doesn’t have any existence separate and apart from the individual sole proprietor. As a result, any income that is earned from the business is considered the income of the individual owner. The sole proprietorship itself is not separately taxed on its income; rather, the sole proprietor reports business income and expenses on their own tax return and pays tax accordingly. This means that the net income from the business is taxed only once. In contrast, the income from a corporation is taxed twice: once when the corporation is taxed, and again when the income is distributed to shareholders in the form of dividends.