A sole proprietorship is the simplest form of business structure. Anyone can be a sole proprietor and there is no legal basis for this business form. The term sole proprietorship simply refers to someone who is engaged in some form of business, and who is responsible for the debts of that business. You can run a sole proprietorship under your own name, or under a “doing business as” (DBA) name, such as Manny’s Sandwiches. The DBA name is just a trade name and does not create a legal entity separate from the sole proprietor.
A sole proprietorship remains a very popular business form because it is simple, easy to create, and has minimal costs. All that is needed is to register your name and your DBA is applicable, and pay for any local licenses if necessary. Once that’s done you’re ready for business. The downside of a sole proprietorship is that the sole proprietor is responsible for all the business debts, and there is no legal shield against lawsuits. If a sole proprietor loses a lawsuit he or she is responsible to pay the judgment from their own money, which could put savings or even their home in jeopardy.
Because the sole proprietorship is not a legal entity, any contracts entered into are typically signed by the owner of the sole proprietorship in their own name. Payments to the business are made in the name of the owner as well, even if they are using a trade name to conduct business. It is not unusual for sole proprietor owners to comingle the business assets and their personal assets, something that is forbidden with traditional corporations and LLCs. Many businesses begin as sole proprietorships and later transform into one of the more complex business structures.
Since the sole proprietorship is indistinguishable from the owner, taxation remains a simple matter. Any income from the sole proprietorship is simply taxed as earnings of the owner, with income and losses filed using Schedule C along with a standard Form 1040. Profits and losses are calculated on Schedule C and are then transferred to the Form 1040 as regular earnings. This can be attractive as any losses suffered by the business can be used to offset income from other sources.
One downside to the sole proprietorship is the need for the owner to also file a Schedule SE, which calculates how much self-employment tax is owed. The owner does not need to pay unemployment tax on themselves, but they are responsible for the full 15% social security tax on gross earnings. In a traditional employment scenario an employee pays just half of the social security requirement, so this can come as a surprise to some new sole proprietors.
Another, and potentially larger downside to being a sole proprietor is that the business owner is responsible personally for any debts the business incurs. This could become quite concerning if an owner were to take out a loan and later have the business fold for some reason. The dissolution of the business would not mean an end to the debt liability. Instead the business owner would be required to pay back the loan from his or her personal assets.
An even more catastrophic scenario is possible. Suppose there is an accident involving the business proprietor or one of their employees. A lawsuit could be brought against the sole proprietor, and even their personal assets would be at risk. You could lose all your savings and even your home!
Anyone considering a sole proprietorship should carefully consider the two preceding paragraphs before continuing. Businesses go out of business, and accidents do occur. It could become heartbreaking to see all your personal assets consumed by such an occurrence.
Still, one of the upsides to a sole proprietorship is the ease with which one can be created. Really all that is needed is the buying and selling of a good or service. There is no need to submit any special paperwork, just the act of conducting a business activity makes one a sole proprietor.