A sole proprietorship is a type of business model that is run by a single individual. Under this structure, the individual is considered the sole owner and thus they can be held personally responsible for any debts or liabilities of the business. In other words, the business and the owner are treated as a single entity, as opposed to separately like corporations and limited liability companies. 

Some examples of sole proprietorships include:

  • Consultants;
  • Freelance writers;
  • Direct sellers;
  • Landscapers; 
  • Fitness instructors;
  • Tutors;
  • Graphic designers or artists; 
  • Home-based business owners;
  • Bookkeepers or tax preparers; and
  • Local shop or restaurant owners.

Additionally, an individual does not need to follow any specific requirements to form a sole proprietorship. Thus, if you perform any of the roles listed above, have total control over your work, and/or conduct a business activity that fulfills this definition, then you may already be the owner of a sole proprietorship. If in applying these conditions you are still uncertain of your status, you should contact a local business lawyer for further legal guidance.

What Are the Characteristics of a Sole Proprietorship?

There are several characteristics that are unique to sole proprietorships. The main feature that separates sole proprietorships from other business structures is that they normally consist of a single business owner. This owner not only owns all of the assets and maintains control over the entire business, but can also be held legally responsible for the wrongdoings of their employees. 

In other words, a sole proprietor can be held fully liable for the unlawful actions of their employees and any other debts incurred by the business. Accordingly, creditors can take legal action against both the assets of the business as well as the personal assets of the owner in order to recoup overdue payments. 

Another prominent feature of sole proprietorships is that the business will continue to exist for as long as a business owner desires. On the other hand, if the owner of a sole proprietorship dies, then the business will become part of the owner’s estate and cease to exist unless it is left to beneficiaries who take on the business. A sole proprietor is also free to transfer all or some of their business by selling company assets

Finally, one last feature that sets sole proprietorships apart from other types of business organizations is how they are taxed. Any profits or debts associated with the business are also directly tied to the owner. Thus, a sole proprietor is required to pay personal income taxes on profits and must report any losses that stem from the business.  

What Are the Pros and Cons of Having a Sole Proprietorship?

There are many advantages to structuring a business as a sole proprietorship. Two primary benefits of sole proprietorships include that they are relatively easy to establish (or wind-down) and that they are much cheaper to create than other kinds of business models. 

This has to do with the fact that sole proprietorships require less procedural steps and paperwork to set-up, which in turn, means that their initial costs will not be as expensive as forming a corporation or a limited liability company. 

As previously mentioned, another advantage of creating a sole proprietorship is that a 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 the business. This makes it easier for compliance purposes as well as helps to keep costs low since profits will be taxed in accordance with an individual income tax rate rather than a corporate tax rate.

In addition, sole proprietors have total and direct control over all business decisions and are not required to share power with any board members or partners. This gives them the authority to take the business in any direction they want. 

For instance, the owner of a sole proprietorship is allowed to hire anyone they wish and may potentially receive certain tax benefits for creating more job opportunities. The owner of a sole proprietorship also enjoys the added bonus of being able to hire their spouse to work for them without having to declare them as an employee. 

However, there are a handful of risk factors that prospective sole proprietors should be aware of before setting-up their business. As discussed above, owners under this model are fully liable for the debts of the business and the wrongdoings of their employees. Thus, if the business experiences overwhelming debt, this can have an effect on the owner’s personal finances as well. 

For example, if the business fails to pay off its debts in time, then creditors may attach a lien to the owner’s home, bank account, and a number of other non-exempt assets to satisfy the business’s debts. 

Also, while sole proprietors gain the advantage of being taxed at a personal income tax rate, this benefit decreases a bit because they will be liable for paying self-employment taxes on any profits that the business earns. 

Another issue with sole proprietorships is that they cease to exist when an owner dies or decides to shut down the business. In both of these scenarios, assets or finances that belong to the business will promptly become part of the owner’s estate. This can have a major impact on employees because their salary will be subject to inheritance taxes, meaning they could see a significant reduction in pay or in their final paycheck.

One last issue with sole proprietorships is that if an owner does not start off with a lot of capital, they may struggle with raising funds for the business since they cannot issue stocks or accept money from investors. Generally speaking, it takes a lot of money to get a business up and running. 

So, if an owner does not have enough of their own money or savings and cannot accept investments because they are not permitted to issue stocks, then it may be very difficult to secure a loan or a line of credit. This can hurt the business’s chances of surviving past the initial stage without going bankrupt. 

How is a Sole Proprietorship Taxed?

As previously mentioned, the revenue from a sole proprietorship gets reported on the business owner’s personal income taxes. Depending on the jurisdiction, some percentage of the business’s profits will be taxed in accordance with the personal income tax rate that applies in a specific location. A business owner will also be responsible for paying self-employment taxes on any profits earned.

Some businesses may be required to pay estimated taxes as well. These are taxes that are paid in increments throughout certain times of the year. In most cases, a sole proprietor will need to pay estimated taxes if they expect to owe at least $1,000 or more in a given tax year, and if they expect that the amount of their withholding and refundable credits will be either less than 90% of the taxes on their return or less than 100% of their tax return from the prior year. 

It is important to note that these rules are subject to change and may not apply to all businesses. For instance, special rules exist to cover fishermen, farmers, household employers, and some high income taxpayers. As such, it is crucial that a business owner review the tax laws in their area. Tax laws can be tricky, however, because they change so often and vary based on the state. 

Thus, a sole proprietor may want to consider hiring a lawyer to assist with this portion of their business. A lawyer can ensure that the business owner understands their obligations under the tax laws in their state, can answer any questions they have about filing taxes for a sole proprietorship, and can provide advice on ways that an owner may be able to legally reduce their taxes. 

Should I Consult a Lawyer about My Business Structure?

It is very important that you understand the laws surrounding particular business structures, file taxes in compliance with state and local regulations, and know what rights you have as a business owner. Therefore, if you have any specific questions or would like to learn more about sole proprietorships, you should contact a local business lawyer for further assistance. 

An experienced business lawyer will be able to answer your questions, can discuss the tax laws and requirements for sole proprietorships in your state, and can determine whether a sole proprietorship is the right type of business organization for your needs. If not, your lawyer can also recommend and explain why another option may be more suitable. 

Additionally, if you need help in preparing and filing the paperwork to set-up your business, your lawyer can also assist you in completing this process as well.