A sole proprietorship is a type of business ownership in which one person owns and operates a firm and there’s no legal distinction between the business and the owner. A sole proprietorship is riskier than a corporation (which is legally distinct from its owners), but it’s more convenient to establish and less expensive to maintain.
Sole proprietorships are a default classification for an individual with a business. If you do not request for your business to be anything else, states will generally assume your business is a sole proprietorship.
You must still decide what to name your company. If needed, it’s your responsibility to apply for required business licenses and set up a separate checking account. You should also look into protecting your venture with small business insurance.
If you’re confident that you’ll usually work alone, a sole proprietorship may be a good idea. Consider it for businesses like:
What are the advantages of being a sole proprietor?
Establishing a sole proprietorship is the quickest and easiest way to start a business. Here’s why this type of business entity is appealing:
- Sole proprietorships have few legal complexities. All you do is select a name, register with your state’s tax-collection agency, apply for a business license (if needed) and start a business checking account.
- Its costs are low. Because you don’t need an attorney to draft incorporation documents and don’t have to pay annual fees to your state, starting a sole proprietorship is highly affordable.
- You can operate the business under your own name. This reduces possible trademark conflict if you select a name already owned by another firm.
- Tax reporting is simple. Since a sole proprietorship’s profits — and losses — flow directly to the business owner, a separate corporate tax return is unnecessary. Sole proprietors report their business profits and losses on their personal tax returns (Schedule C of Form 1040).
- Business losses are tax deductible. If your company loses money, you can deduct your losses on Schedule C, thereby lowering your tax liability. And since your business income flows to your personal tax return, you may be eligible to deduct 20% of your net business income from your reportable business income.
- Sole proprietors call all the shots. Because you’re the sole owner and decision-maker of your business, you don’t have to share power with other executives or board members. You also own all the profits.
- You don’t have to pay into your state’s unemployment fund for yourself. This lowers your operating costs.
What are the disadvantages of sole proprietorship?
Sole proprietorships don’t shield your personal assets from third-party claims. For example, if you make a professional mistake, customers could come after your business assets for damages if they win. But they could also target your personal holdings such as your house and retirement savings.
Corporations and LLCs shield your personal assets against legal attack. For example, if you declare bankruptcy as an LLC, your creditors can’t go after your personal investments or family home.
Here are six other disadvantages of sole proprietorships:
- You must report business income on your personal tax return in the year you earned it. While corporations have the flexibility to determine the form and timing of owner’s compensation, you have to pay a self-employment tax on your net business income equal to 15.3% of your net earnings.
- The full stress and burden of running the business falls on you. As a one-person company, you savor the joy of making a big sale. But you also fully shoulder hardships like losing an important customer.
- Some people don’t perceive sole proprietorships as a real business. Even though 86% of businesses are run by “solopreneurs,” the stigma that it’s not a “real” or professional business can make it harder to add new customers.
- Sole proprietors may have difficulty raising capital. Sole proprietors can’t raise capital by selling ownership shares. This mostly limits their financing options to bank loans.
- You can’t collect unemployment benefits. If you’ve never paid into unemployment insurance and your business fails, you’re out of luck.
- You might have trouble selling your business. As a sole proprietor, it’s difficult to quit and sell your business to a new owner. Your departure usually spells the end of your venture.
Get small business insurance for your business
In the event of something unexpected, NEXT can help you manage the operating risks of your sole proprietorship or small business. We’ll process your covered loss to help you get back to work fast.
NEXT is 100% dedicated to small business. Our small business insurance helps you take the risks you need to grow and scale your business.
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