In a previous article, the various types of business entities were broadly discussed. This is the first article focusing on a single, specific type of entity, and this one is perhaps the simplest to structure and operate. Simplicity, though, should not be the sole determinative factor. When you are starting a business, there are numerous other factors that a business owner must consider, including potential liability and tax implications.
Generally, a sole proprietorship does not require any formal action to form. As the name implies, the business owner is the sole/only owner of the business. While the business owner is still required to obtain necessary licenses and permits depending on the type of business being operated, there may be no filing requirements with the Secretary of State. This simplicity in formation and inexpensiveness is perhaps the greatest advantage of starting a sole proprietorship.
The only filing that may be required is if the owner chooses to operate the business under any name other than the individual’s name. If that is the case, then a filing is required with the Secretary of State for an “Assumed Business Name.” For example, if John Doe decides to operate a sole proprietorship, but wants to operate it as “John Doe’s Cleaning,” then the owner must file for an Assumed Business Name with the Secretary of State.
Continuing the pattern, tax preparation is made simple. A sole proprietorship is taxed on the personal income tax return of the owner; this is “pass-through” taxation, which is a type of taxation business owners should understand, as it is used in numerous other forms of businesses. With “pass-through” taxation, the profits and losses from the business are reported on a Schedule C, which is attached to the owner’s personal tax returns. Essentially, if the business operations result in a net profits or losses, those profits or losses are included in the income of the owner’s tax returns.
While the formation is simple, it does not come without a downside. A sole proprietorship also comes with unlimited personal liability for the owner; there is no legal separation between the owner and the business as there would be with a corporation or an LLC. If a person has a claim against the business, the owner can be held personally liable.
If you believe you want to start a business and think a sole proprietorship is your best and most suitable option, you should consult with an attorney to determine whether there is a different option that might be more appropriate.