A sole proprietorship is a business that does not involve the complexities and expenses of formal incorporation procedures. It is owned by an individual. The owner operates the business, is personally liable for all business debts, and can freely transfer all or part of the business. If a lawsuit is filed because the business owes money or because someone was harmed by the business, the owner (the sole proprietor) is personally liable for any judgment that the plaintiff might be awarded by the court.
In this form of business, the law and the taxing authorities (IRS, etc.) do not distinguish the business from the individual who owns it. Profit or loss is reported on the owner’s personal income tax return and all net income is taxed to the individual at his/her personal tax rate. If the business has employees, the owners are required by law to withhold federal income taxes, state income taxes and FICA (Social Security) Insurance from the wages paid to employees.
Advantages of a Sole Proprietorship over other Business forms:
- It is simpler to form than a corporation, LLC, LLP, partnership or LP, and the startup costs for a sole proprietorship are minimal.
- The sole proprietor controls all of the financial and management decisions and receives all of the profits.
- The business’ net earnings are not subject to corporate income tax, but are taxed as personal income. All profits and losses of the business are reported directly to the owner’s income tax return. A separate tax return for the business or balance sheet is not required.
- Decision-making is in the direct hands of owner.
Disadvantages:
- The owner is subject to unlimited personal liability for the debts of the business. Both the business and personal assets of the sole proprietor are subject to the claims of creditors.
- It is difficult for a sole proprietorship to raise capital. Financial resources are generally limited to the owner’s funds and any loans outsiders are willing to provide. Corporations can issue stock and raise capital that way.
- Owner could spend unlimited amount of time responding to business needs.
- Because a sole proprietorship is not a separate legal entity, it usually terminates when the owner becomes disabled, retires, or dies. As a result, the sole proprietorship lacks continuity and does not have perpetual existence like other business organizations.
- Some employee benefits, such as owner’s medical insurance premiums, are not directly deductible from business income (only partially deductible as an adjustment to income).