Is Sole Proprietorship Right for You?
By: Melanie Shires, PCC
Are you a new entrepreneur and wondering what business structure is best for you? This is one of the first and most important business choices you will make. Your choice in legal structure can have a significant impact on your business, determining everything from your day-to-day operations, how you pay taxes owed, to how much personal assets are at risk.
As an entrepreneur, you may be thinking the best way to go is the easiest – sole proprietorship.
Sole proprietorship is the simplest way to operate a business. If you're self-employed or conducting any kind of business and haven't picked a formal business structure, then by default, you're operating as a sole proprietor. A sole proprietorship is defined as an unincorporated business owned by one person who pays personal income taxes on profits.
In other words, a sole proprietorship is not a separate entity from its owner. For better or worse, you are the business and the business is you. This has advantages and disadvantages, depending on your specific set of circumstances. Here's what you need to know:
The biggest advantage of a sole proprietorship is that there is no one else to answer to and all profits and assets of the business are yours.
You still need to file some basic paperwork with your state’s secretary of state and the IRS. However, setting up a sole proprietorship is simple to both form and manage. All you need to do to run a business as a sole proprietor is to register the business name via a DBA — if you will be using a business name that's different than your own name — and get any required local business licenses.
When you incorporate a business, you're required to operate at a higher administrative level. This means preparing formal financial statements, keeping separate accounting books from your personal financial information, holding annual meetings, keeping meeting minutes, filing reports with the state, etc. Many entrepreneurs and small business owners aren't interested in keeping up with all that paperwork making sole proprietorship a good option.
When it comes to reporting your taxes, since there's no separation between the sole proprietorship and the owner, any income earned by the business is considered income earned by the owner. A sole prop owner just needs to keep track of all the business' income and expenses and report it on a Schedule C with their personal tax return. Say your business operates at a loss in its first few years. Claiming the hit on your personal tax return can lessen your tax burden.
Personal Liability Risk
While the sole proprietorship is undeniably easier, it also entails some serious drawbacks. The biggest drawback being that the owner of a sole proprietorship is personally liable for any debts of the business. That means if you default on a business loan, lenders can come after your personal assets such as real estate, cars and some investments.
If you’re concerned about lawsuits, you should think twice about a sole proprietorship. If for some reason you can’t meet a deadline for a customer, you could be sued and found liable for damages. If your employee causes a car crash while working and hurts someone, you may be liable for the injured party’s medical expenses. In either case, there’s no distinction between business and personal assets because they are all part of the same whole: you.
Now that you know both the pros and cons of sole proprietorship, you are better informed to make a wise decision. If you find that the independence, simplicity and low costs outweigh the risks, a sole proprietorship may be right for you.
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