A sole proprietorship is a unincorporated business owned by one individual, making it the simplest form of business to start and operate.
The sole proprietorship is not a legal entity. It simply refers to a person who owns the business and is personally responsible for its debts. A sole proprietorship can operate under the name of its owner or it can do business under a fictitious name, such as Nancy's Nail Salon. The fictitious name is simply a trade name--it does not create a legal entity separate from the sole proprietor owner.
The sole proprietorship is a popular business form due to its simplicity, ease of setup, and nominal cost. A sole proprietor need only register his or her name and secure local licenses, and the sole proprietor is ready for business. A distinct disadvantage, however, is that the owner of a sole proprietorship remains personally liable for all the business's debts. So, if a sole proprietor business runs into financial trouble, creditors can bring lawsuits against the business owner. If such suits are successful, the owner will have to pay the business debts with his or her own money.
Using Your Real Name
As long as you use your personal name as your business name, you don’t have to file any paperwork about that either. However, if you want to name your business something other than your name, you may need to file papers to indicate you are “Doing Business As…,” which is also known as a DBA form. Many, but not all, states require DBA or “fictitious name” forms in that case. Before your state or county courthouse will accept your DBA filing, you’ll first need to check to verify that no one else is using that name; you can’t use a name someone else has claimed.
The owner of a sole proprietorship typically signs contracts in his or her own name, because the sole proprietorship has no separate identity under the law. The sole proprietor owner will typically have customers write checks in the owner's name, even if the business uses a fictitious name. Sole proprietor owners can, and often do, commingle personal and business property and funds, something that partnerships, LLCs and corporations cannot do. Sole proprietorships often have their bank accounts in the name of the owner. Sole proprietors need not observe formalities such as voting and meetings associated with the more complex business forms. Sole proprietorships can bring lawsuits (and can be sued) using the name of the sole proprietor owner. Many businesses begin as sole proprietorships and graduate to more complex business forms as the business develops.
You are your business, any revenue you earn from your business is considered personal income, which you pay personal taxes on. Although you won’t have additional business taxes, you will pay self-employment taxes and estimated taxes, based on what you earned the previous quarter. Check with the IRS to learn how to track and pay those amounts.
Because a sole proprietorship is indistinguishable from its owner, sole proprietorship taxation is quite simple. The income earned by a sole proprietorship is income earned by its owner. A sole proprietor reports the sole proprietorship income and/or losses and expenses by filling out and filing a Schedule C, along with the standard Form 1040. Your profits and losses are first recorded on a tax form called Schedule C, which is filed along with your 1040. Then the "bottom-line amount" from Schedule C is transferred to your personal tax return. This aspect is attractive because business losses you suffer may offset income earned from other sources.
The salient features of sole proprietorship form of organization are as under:
1. Single Ownership. A sole trading concern is owned by one individual. It is run entirely at his risk of loss. The sole trader provides both capital and management to the business.
2. Personal Organization or Common Identity. A sole trader ship concern has no separate legal entity independent of the owner. The owner and the business concern are one and the same. The owner owns everything the business owns and he owes everything the business owns.
3. Capital. In sole trader ship, the capital is employed by the owner himself from his personal resources. He may also borrow money form his friends and relatives if he cannot depend solely on his personal resources.
4. Unlimited Liability. The liability of the proprietor for the debts of the business is unlimited. The creditors have the right to recover their dues even from the personal property of the proprietor in case the business assets are not sufficient to pay their debts.
5. One Man Control. Sole trader ship is one-man show. The sole trader provides management to the business. He takes all the decisions, procures material resources, employs persons and directs and controls the affairs of the enterprise. He is not required to consult anyone else in taking any decision. Though the sole trader may delegate some of his authority to his assistants but the ultimate authority to manage and control rests with him.
6. Profits and Losses. The surplus arising in the business of the sole trader entirely belongs to him and similarly all the business losses and risk are to be borne by him alone.
7. No Special Legislation. Sole trader ship is not governed by any special legislation. A partnership firm is governed by the Partnership Act, a joint stock company is governed by the Companies Act and co-operative society by the Co-operative Societies Act. Any person who is competent to contract can start his business as a sole trader. However, he is subject to the common law, the law of contract and the law of insolvency.
Advantages of a Sole Proprietorship
- As a sole proprietor you own 100% of the business and as such get to make all the decisions.
- A sole proprietorship is the easiest form of business to set up. If you operate your business under your own name, with no additions, you don't even need to register your business name to start operating as a sole proprietor. This makes the sole proprietorship ideal for the business startups, self-employed contractors, and part-time and home-based businesses.
- Sole proprietorships are much simpler to operate from a tax and accounting perspective. As a sole proprietor you do not need to file a separate business tax return - all income generated from the business is reported on the personal tax form. Here's How to Complete Your T1 Canadian Income Tax Form.
- As with other forms of business, as a sole proprietor your expenses related to the cost of doing business are fully deductible from income tax, as are travel expenses, automobile expenses, advertising, and a portion of your home expenses if you are operating a home-based business.
- Business losses can be deducted against other forms of income or carried forward or backward, so a sole proprietorship that loses money in the early years can deduct the losses against personal income, making it ideal for those wishing to transition from employee to self-employed over a period of time.
Disadvantages of a Sole Proprietorship
- Since there is no legal separation between you and the business, as a sole proprietor you are personally responsible for all the liabilities and obligations your business incurs. This means that as a sole proprietor if the business fails or if you are sued for damages caused by accident or negligence in the course of your business activities, your personal assets (including your home and any other assets registered in your name) could be seized to discharge the liability. With an incorporated business or partnership the personal assets of the owner(s) are separate from the assets of the business and as such are protected from seizure for debt obligations or liability. Having sufficient business insurance is very important for sole proprietorships as it is with other forms of business.
- While tax simplicity can be an advantage for sole proprietorships, it can also be a disadvantage in terms of flexibility, as all business income must be reported as regular income in the year in which it was earned. Incorporated companies have much more flexibility in terms of how and when the owners are paid.
- Some businesses, government agencies, consulting groups, etc. will not deal with unincorporated businesses.
- Raising capital is more difficult for sole proprietorships - incorporated companies can raise equity financing from angel investors or venture capitalists by selling shares in the business.
- Sole proprietorships can be difficult to sell as the business is completely tied to the owner - since there is no distinction between the assets of the owner and the assets of the business proper valuation of the business can be hard to achieve. Death or long term illness of the owner can render the business worthless. Customer loyalty resides with the original owner of the business and may not readily transfer to a new owner.