Advantages and Disadvantages of Sole Proprietorships
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What Is a Sole Proprietorship?
A sole proprietorship is a simple type of business structure that is owned and operated by the same person. It does not involve many of the complex filing requirements associated with other types of business structures such as corporations. Sole proprietorships allow persons to report business income and expenses on their individual tax returns.
Sole proprietorships are attractive to small investors because they are relatively easy to start up. Also, the owner is entitled to all the profit that the sole proprietorship collects. On the other hand, sole proprietorships can be risky because there is no separation between the owner and the business.
In other words, the owner remains personally liable for any losses or debts that the sole proprietorship incurs. They can also be held legally responsible for violations committed by the business or its employees. A sole proprietorship can best be summed up by the phrase, "You are the business."
What Are Some of the Advantages of a Sole Proprietorship?
There are many reasons why a person would choose to start their business up using a sole proprietorship structure. Some of the main advantages of sole proprietorships include:
- Ease of formation: Starting a sole proprietorship is much less complicated than starting a formal corporation, and also much cheaper. Some states allow sole proprietorships to be formed without the double taxation standards applicable to most corporations. The proprietorship can be named after the owner, or a fictitious name can be used to enhance the business’ marketing.
- Tax benefits: The owner of a sole proprietorship is not required to file a separate business tax report. Instead, they will list business information and figures within their individual tax return. This can save additional costs on accounting and tax filing. The business will be taxed at the rates applied to personal income, not corporate tax rates.
- Employment: Sole proprietorships can hire employees. This can lead to many of the benefits associated with job creation, such as tax breaks. Also, spouses of the business owner can be employed without having to be formally declared as an employee. Married couples can also start a sole proprietorship, though liability can only assumed by one individual.
- Decision making: Control over all business decisions remains in the hands of the owner. The owner can also fully transfer the sole proprietorship at any time as they deem necessary.
What Are the Disadvantages of Sole Proprietorships?
Forming a sole proprietorship does involve some risks, mainly to the owner of the business, as legally speaking they are not treated separately from the business. Some disadvantages of sole proprietorships are:
- Liability: The business owner will be held directly responsible for any losses, debts, or violations coming from the business. For example if the business must pay any debts, these will be satisfied from the owner’s own personal funds. The owner could be sued for any unlawful acts committed by the employees. This is drastically different from corporations, wherein the members enjoy limited liability (i.e., they cannot be held liable for losses or violations)
- Taxes: While there are many tax benefits to sole proprietorships, a main drawback is that the owner must pay self-employment taxes. Also, some tax benefits may not be deductible, such as health insurance premiums for employees
- Lack of “continuity”: The business does not continue if the owner becomes deceased or incapacitated, since they are treated as one and the same. Upon the owner’s death, the business is liquidated and becomes part of the owner’s personal estate, to be distributed to beneficiaries. This can result in heavy tax consequences on beneficiaries due to inheritance taxes and estate taxes
- Difficulty in raising capital: Since the initial funds are usually provided by the owner, it can be difficult to generate capital. Sole proprietorships do not issue stocks or other money-generating investments like corporations do
So, while sole proprietorships do not necessarily create more liabilities, they do expose the business owner to a risk of being sued. Lawsuits can be filed against the business owner for legal violations, as well as to collect any outstanding debts.
Do I Need a Lawyer to Start a Sole Proprietorship?
If you plan on starting a sole proprietorship, you should be fully aware of the various pros and cons that are involved in such a business endeavor. It would be a wise decision to consult with a business lawyer before you file for sole proprietorship. Business laws vary from state to state, and a business attorney can help explain the various laws to you. Also, your lawyer can help you calculate the risks involved and help determine whether a sole proprietorship is the right business structure for you.
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Last Modified: 06-18-2014 12:15 PM PDT
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