A sole proprietorship is a type of business organization that is owned by a single individual. Under this type of business structure, the individual is considered the sole owner. Thus, they can be held personally responsible for any debts or liabilities incurred by the business. In other words, the business and the owner are treated as a single entity in a sole proprietorship.
Some common examples of sole proprietorships may include:
- Freelance writers;
- Direct sellers;
- Fitness instructors;
- Graphic designers;
- Bookkeepers; and
- Local restaurant or store owners.
In addition, a business owner does not need to comply with any specific requirements to form a sole proprietorship. As such, if you perform any of the roles in the above list, have complete control over your work, and/or participate in a business activity that fulfills this exact definition, then you may already be the owner of a sole proprietorship.
Lastly, if after applying these conditions you are still uncertain of your ownership status, you should contact a local business lawyer for further legal advice.
How Do Sole Proprietorships Differ from Other Business Models?
There are a handful of characteristics that are unique to sole proprietorships. The main feature that separates sole proprietorships from other types of business structures is that they typically are operated by a single business owner. Hence, the “sole” in the name of this business structure (i.e., sole proprietorship).
In most cases, the owner of a sole proprietorship has total power over the entire business, owns all of its assets, and has the ability to hire and fire as they wish. However, this also means that the owner can be held legally responsible for the wrongdoings of their employees as well as for any debts incurred by the business. Accordingly, creditors are permitted to place liens against both the owner’s business and personal assets to satisfy debts.
In contrast, business organizations like corporations and limited liability companies are controlled by multiple persons, such as board members and general or limited partners. Corporations and limited liability companies also typically shield their owners from being liable for company debts.
Another distinctive feature of sole proprietorships is that the business may continue to operate for as long as its owner desires. If the owner of a sole proprietorship dies, however, then the business will be lumped in with the owner’s estate and thus will cease to exist unless it is granted to beneficiaries who take over the business. The owner of a sole proprietorship is also free to transfer all or some of their business by selling company assets.
The same cannot be said for corporations, partnerships, and limited liability companies. With these structures, all of the business owners have to participate in a vote or agree to the sale or transfer of company assets. There are also varying rules for when a member or partner dies.
Finally, one last feature that sets sole proprietorships apart from other types of business models is how they are taxed. Any profits or debts that are connected to the business are also tied directly to its owner. Therefore, sole proprietors are required to pay personal income taxes on profits and must report any losses that stem from a business.
What are the Advantages of Sole Proprietorships?
There are many advantages to registering a business as a sole proprietorship. However, the most significant benefits that sole proprietorships can offer business owners include:
- That they are relatively easy to set-up and/or wind-down; and
- That it is less costly to register a sole proprietorship when compared to other types of business structures.
The reason as to why it may be cheaper to register a business as a sole proprietorship is because they require less paperwork and fewer procedural steps to set-up. In general, this means that the upfront costs to start a sole proprietorship will typically be less than what is needed to register as a corporation or limited liability company.
Another advantage of creating a sole proprietorship is that the business owner will only need to file their personal income taxes during tax season, as opposed to having to file separate tax forms for both themselves and their business. This will not only make it easier for a business owner to comply with state and federal tax laws, but will also help keep costs low. This is because any profits will be taxed in accordance with income tax rates as opposed to corporate tax rates.
Additionally, the owner of a sole proprietorship usually has complete control over all business decisions. Unlike other kinds of business structures, owners of sole proprietors are not required to share power with board members or partners. This gives them the authority to ultimately steer their business in any direction they want.
For instance, the owner of a sole proprietorship is allowed to hire anyone that they wish. In doing so, they could potentially receive certain tax benefits for creating more job opportunities in their community. The owner of a sole proprietorship is also granted an extra bonus of being able to hire their spouse to work at the business without having to declare them as an employee.
What are the Disadvantages of Sole Proprietorships?
Despite all of the wonderful benefits that sole proprietorships have to offer, there are a handful of disadvantages that business owners should be aware of before selecting this type of organization for their business.
As previously mentioned, owners of sole proprietorships can be held fully responsible for debts and liabilities incurred by the business, as well as the wrongdoings of their employees. So, if a sole proprietorship experiences overwhelming debt, this can also impact the owner’s personal assets as well.
For example, if a business fails to pay off its debts in time, then creditors who loaned the business money will be legally permitted to attach a lien to the owner’s home, personal bank account, and/or a number of other nonexempt assets to offset the business’s debts.
Additionally, though sole proprietors have the advantage of being taxed at a personal income tax rate instead of the standard corporate tax rate reserved for most businesses, the beneficial effects are reduced by the fact that they will be liable for paying self-employment taxes on any revenue that the business earns. Consequently, in some ways, this advantage cancels itself out.
Another major issue with sole proprietorships is that the business will cease to exist if the owner dies or decides to close down the business. In either scenario, any remaining assets that belong to the business will immediately become part of an owner’s estate. This action can result in negative consequences for a business’s employees since their salaries will then be subject to inheritance taxes, meaning their final paychecks could suffer heavy reductions.
One last important disadvantage to keep in mind about sole proprietorships is that if an owner does not start the business with a lot of capital, then the owner might struggle to raise funds for the business. Generally speaking, it takes a lot of money to get a business up and running. However, sole proprietors are not allowed to issue stocks and cannot accept money from investors.
Therefore, if an owner does not have enough money and they also cannot accept investments or issue stocks, then it might make it very difficult for them to secure a business loan or establish a line of credit. Consequently, this can potentially hurt a business’s chances of surviving past the initial stage without going bankrupt.
Can a Lawyer Help Me Decide if a Sole Proprietorship is Right for Me?
It is very important that you understand and comply with the various laws surrounding different business structures. Therefore, if you would like to learn more about sole proprietorships and whether this type of organization is the right fit for your business, then you should speak to a local business lawyer for further guidance.
An experienced business lawyer will be able to answer all of your questions and can discuss the tax laws and requirements for sole proprietorships in your state. Your lawyer can also determine whether a sole proprietorship is the best option for your business or why another business structure may be better suited to your needs.
In addition, if you need help with preparing and filing the paperwork to register your sole proprietorship, your lawyer can assist you with this process as well. Remember, each state has separate requirements for registering a business. Thus, a business lawyer can be a useful resource to rely on and to ensure that your business does not fail due to lack of compliance.