Do you operate your own one-person business, or are you otherwise a self-employed individual?
If you answered yes to this question, and you don’t already have a limited liability company or corporation, you are already operating a sole proprietorship. Of all the possible business types in the American business landscape, the sole proprietorship is the simplest one.
With a sole proprietorship, there’s no obligation for you to operate your business according to any rigid formal guidelines, and there isn’t even a formation process for this type of business either.
We’ve noticed that our readers have quite a few questions about how the sole proprietorship works, so we decided to write this article as a means of answering them.
We’ll walk you through the details of a sole proprietorship, along with the advantages and disadvantages of this business type. Along the way, we hope to help you determine if the sole proprietorship is the best option for your one-person business, or whether a limited liability company would be a better fit.
What Is a Sole Proprietorship?
Along with the general partnership, the sole proprietorship is one of the most basic and simple American business entities, and there are hardly any rules or regulations regarding its formation or maintenance.
If you want to create a new sole proprietorship, all you need is to start doing work independently.
You’ll often see people speak of the general partnership and the sole proprietorship in the same breath, and for good reason ― these business types are not considered by the government to be distinct legal entities from their owners.
Rather, the general partnership and the sole proprietorship are treated legally as extensions of their owners’ personalities. In other words, your sole proprietorship is not a separate entity from you as an individual.
The sole proprietorship is so casual in its structure that it doesn’t even need a business name. In fact, many sole proprietorships operate under the individual name of its owner. For example, if your name is Sam Smith, you can simply refer to your sole proprietorship as “Sam Smith” ― no assumed name is necessary.
What Are the Advantages of the Sole Proprietorship?
The most significant positive aspect for sole proprietorships is the lack of any sort of formation process.
Unlike limited liability companies, limited partnerships, and corporations, there is no document filing required to form a sole proprietorship with your state government. In addition, you don’t have to pay a formation fee, which all of those other business entities are required to do. All you need to do to get a sole proprietorship off the ground is simply start working.
Along those same lines, a sole proprietorship is not required to complete any ongoing maintenance tasks either. Whereas more formal business structures typically need to file annual reports with their state ― and also often have to complete other compliance tasks like paying franchise tax ― sole proprietors don’t have to worry about any of these things.
Another money-saving aspect of the sole proprietorship is the fact that you don’t need to designate a registered agent for your business. Formal business entities are required to have a registered agent or registered agent service to receive important document deliveries from the state and forward them to the company, which can often cost well over $100 per year. However, because of the informal nature of the sole proprietorship, a registered agent is not required.
What Are the Disadvantages of the Sole Proprietorship?
While there are a few cost-saving measures that are definite positives for the sole proprietorship, there are plenty of downsides as well. One significant negative compared to formal business structures is the sole proprietorship’s lack of limited liability protection.
An LLC provides personal asset protection to its owners, which protects your car, house, personal bank accounts, and other personal assets in case of a lawsuit against your business. The sole proprietorship has no such protection.
This means that if your business is successfully sued, your creditors can pursue your business assets as well as your personal assets. Obviously, this can be an extremely serious issue, and a significant lawsuit could bankrupt not just your sole proprietorship, but also you as an individual.
Another disadvantage is the sole proprietorship’s lack of a unique business name. While a sole proprietor can acquire a doing business as (DBA) name, this does not give you exclusive rights to your chosen name. In fact, if another entrepreneur decides that they like your company’s DBA name, they can register a formal business entity with that name, which can then actually prevent you from using it anymore.
A sole proprietorship also can’t expand to be operated by more than one person, but rather is restricted to one-person ownership. This is in contrast to the limited liability company, which can be operated as either a single-member LLC or a multi-member LLC.
How Is a Sole Proprietorship Taxed?
The sole proprietorship is a “pass-through” entity for taxation purposes, so there is no tax paid on the business level, and there’s no corporate tax return to worry about.
Instead, the sole proprietorship’s profits and losses pass through the business entity to its owner, and that individual then claims that money on their own personal taxes.
Because the sole proprietor is considered to be a self-employed person, you will need to pay self-employment taxes on any income earned through your business. Self-employment tax encompasses both the employer and employee portions of Medicare and Social Security, which comes to a total of 15.3%. This amount is in addition to your income tax responsibilities.
When it comes to American business structures, the sole proprietorship is as simple as it gets. There is no formation process, and there aren’t any ongoing maintenance requirements to adhere to either. If you want the ultimate in casual flexibility for a business with one owner, the sole proprietorship might be a good choice for you.
On the other hand, the lack of legal protections for sole proprietorships can be a major drawback. The sole proprietorship doesn’t offer personal asset protection like the LLC does (which is very easy to setup on your own or through an LLC service like LegalZoom), and you can’t secure the rights to a unique business name with this type of business either.
Still, if your priority is to form the most basic business possible, with as few rules and regulations as you can find, the sole proprietorship can certainly provide those aspects. We hope this article answered your questions about sole proprietorships, and we wish you the best of luck with your new business!