If you are considering the launch of a new business, a sole proprietorship is a business structure you will want to consider. The questions, what is a sole proprietorship?
A sole proprietorship is the least complex and most common business structure chosen to start a business. In fact, a sole proprietorship is the default business designation if you were to begin your business activity today without filing for a more complex business formation. A sole proprietorship is an unincorporated business. It is owned and operated by one individual with no distinction between the owner and the business. The sole proprietor is entitled to all the profits and is personally responsible for all of the business debts, losses, and liabilities.
What is a sole proprietorship?
The name sole proprietorship is a concatenation of two words sole + proprietorship. Sole is defined as being the only one. A proprietor is defined as a person who has the legal right to or exclusive title to something. Together, sole proprietorship means being the single owner.
But you likely expected that definition. There has to be more to it than just that. The answer is yes, there is. A sole proprietorship is an unincorporated business. Let’s talk about that.
Note: I am a small business owner who writes on business-related topics. Such topics often include legal elements. The information here is not legal advice. Utilize the topics here in preparation for your discussion with your legal counsel.
What is an unincorporated business
An unincorporated business is a business that is not a separate entity. In the case of a sole proprietorship, the owner of the business and the business itself are one and the same. This is very important to understand. There is no distinction between the owner of the business and the business itself. As such, there is no shield or protection between the owner and the business. This renders the owner personally liable for all the debts and obligations of the business. More on that later.
How to Start a Sole Proprietorship
Sole proprietorships are the simplest and most common business structure chosen when starting a business. In fact, a sole proprietorship is the default business designation if you were to begin your business activity today without filing for a more complex business formation. There are no state-level filings necessary to form a sole proprietorship. There may be state and municipal fees required for permits, licenses and assumed business name filings.
Note: This article contains affiliate links. That means we may get paid a commission if you purchase something through one of our links. There is no additional cost to you. It is simply how we fund Efficient Soloprenuer.
What is an Assumed Business Name
The sole proprietor and the business are legally one and the same. Therefore a business owner is free to operate the business under their legal name. However, the sole proprietor may elect to operate the business under an Assumed Business Name. This is also called a fictitious name, an assumed name, or a doing business as (dba) name.
How Much Does a Sole Proprietorship Cost
A sole proprietorship enjoys the lowest cost business structure startup cost. Unlike the most complex business structures, a sole proprietorship isn’t required to file articles of organization or articles of incorporation with the States Secretary of State. Subsequently, a sole proprietorship isn’t required to maintain its business declaration. This saves the owner hundreds of dollars per year.
There may be initial and ongoing state and municipal fees required for permits and licenses. If the owner prefers to operate the business under an assumed business name, a one-time filing with the Register of Deeds is required.
With this low start-up cost, one might think a sole proprietorship might be a favorite business structure among solopreneurs. However, there is more to consider when understanding what a sole proprietorship is. We’ll discuss that are you read further.
How does a Sole Proprietorship Pay Taxes
Because the business owner and the business are unincorporated, the business itself is not taxed separately from the owner. The income from the business activity is the sole proprietor’s income. The proprietor reports the business income, losses and expenses in Schedule C along with their annual income tax filing using Form 1040. The bottom line amount from the Schedule C is used on your personal tax return. You are responsible for withholding and submitting all income taxes, including self-employment taxes and estimated taxes.
How do Sole Proprietors get Paid
Sole proprietors are responsible for stewarding their profit, losses, expenses, deductions, and withholding self-employment and estimated taxes. The owner is compensated by taking an owner’s draw. The frequency and amount of this draw are at the owner’s discretion limited only by the balance and credit of the business account.
The owner’s draw should be done with a great understanding of the business responsibilities ahead. Keep in mind, the owner is personally responsible for all the debts and obligations of the business.
How Often do Sole Proprietors Pay Taxes
Sole proprietorships may be responsible for several different taxes.
Some taxes are due annually, such as:
- Income tax
- Franchise tax
Some taxes are due quarterly, such as:
- Payroll taxes
- Self Employment taxes
- Estimated taxes
- Property taxes
Some taxes are due monthly, such as:
- Sales taxes
- Excise taxes
As always, consult your CPA and/or Tax Attorney to understand the requirement and frequency based on your business activity and municipal, state and federal requirements.
Sole Proprietorship Liabilities
A sole proprietorship provides unlimited personal liability. This is one of the sole proprietorships biggest disadvantages. Because the business is unincorporated, meaning there is no legal separation between the individual owner and the business obligations, the business owner can be held personally liable for the debts and obligations of the business. This risk extends to any liabilities incurred as a result of employee actions.
Investment Opportunities
Because the business and the business owner are one and the same under a sole proprietorship, it can be difficult to raise capital for the business. Investors have limited opportunities to invest in a sole proprietorship outside of providing loans. Remember, if an investor were to invest capital in exchange of an ownership share, the business would technically no longer be a sole proprietorship. It would need to reclassify its business structure.
Banks will closely consider the owner’s personal ability to repay any loan obligation.
The lifespan of a Sole Proprietorship
A sole proprietorship is an unincorporated business and therefore one and the same with its owner. A sole proprietorship lacks business continuity and does not perpetual existence. A sole proprietorship ceases when the owner terminates business or passes away.
Advantages and Disadvantages of Sole Proprietorship
Advantages of a Sole Proprietorship
- Simple business structure: A sole proprietorship is the simplest business structure to form. In fact, a sole proprietorship is the default business designation if you started your business today without filing for a more complex business formation.
- Inexpensive to form: A sole proprietorship is also the least expensive business structure to form.
- Complete control: The proprietor is the sole decision-maker in the business.
- Simplest tax compliance: The business and the owner are taxed together. There are a few additional tax considerations when taking on a business. However, a sole proprietorship has the easiest requirements and lowest tax rates of any business structure.
Disadvantages of a Sole Proprietorship
- Unlimited personal liability: With no separation between the business owner and the business liabilities, the sole proprietor is can be personally liable for all the debts and obligations of the business.
- Difficult to raise capital: Sole proprietors have limited ability to raise capital via investment due to the business structure. Loans can also be difficult because bankers closely consider the repayment ability of the owner.
- The burden of responsibility: With the sole and complete control, the business owner has the burden of success on their shoulders, alone.
I hope this has been helpful in improving your understanding of what is a sole proprietorship. With this improved understanding, you may wonder how the sole proprietorship compares to the other popular business structure. I’d encourage you to review this article on the Best Business Structures for Solopreneurs.
Note: This article is written based on the definitions established here in the United States of America. Similar business structures exist worldwide. Definitions are different and nuanced based on the jurisdiction in which you reside.
Enjoy Life as a Solopreneur
Becoming a solopreneur can change your life for the better. You can take full advantage of the flexibility and control while capitalizing on your passion and honing important skills.
If you are a solopreneur, you are in the right place. The Efficient Solopreneur is here to help you work smarter and eclipse your goals! Join YOUR tribe and subscribe to our mailing list. We will help you stay abreast of the information to help you gain and maintain a competitive advantage!
Sources: