Cons To Setting Up A Sole Proprietorship
There are certainly cons to setting up a sole proprietorship, the first of which is that the owner is personally liable for all of the business debts and obligations. While it is easy to understand that the owners personal bank accounts may be responsible for paying business debts in the event the business fails, there is another very important consideration: liability for negligence or accidents.
Cons of Sole Proprietorship example:
Amelia opens a tea shop and reading room. Customers find a broad selection of teas and other beverages, and often gather in the comfortable sitting groups to chat, surf the web, and relax. One day, John, an employee at Amelias Tea Shoppe, notices a puddle near one of the settees, but becomes distracted before he can clean it up.
Customer Suzy slips in the puddle and falls, striking her head on the arm of a chair. The Tea Shoppe will likely be responsible for paying Suzys medical bills, but if Suzy sues the business for negligence, she can also sue Amelia personally, or seek to collect her judgment from Amelias personal assets.
Another disadvantage of a sole proprietorship is the challenge of raising money to fund the business startup. Because the business cannot sell stock, and obtaining credit would depend on Amelias personal credit score, obtaining much-needed capital may be difficult.
Limited Partnerships Differ From Limited Liability Partnerships
When choosing a business form, you may want to consider the limited liability partnership , one of the newest entity options. Do not confuse a limited partnership with a limited liability partnership . In many states, a general partnership has the option of registering as a Limited Liability Partnership, which confers some degree of liability protection on all the partners.
Thus, an LLP is similar to an LLC, in that all of the owners have limited liability . In contrast, in an LP, at least one owner must be a general partner, who has unlimited personal liability. Further, in an LLP, all of the owners can participate in management. In contrast, in an LP, limited partners are prohibited from participating in management.
Payment Of Taxes On Business Income
A sole proprietor pays taxes by reporting income on a T1 income tax and benefit return.
If you are a sole proprietor, you or your authorized representative have to file a T1 return if you:
- have to pay tax for the year
- disposed of a capital property or had a taxable capital gain in the year
- have to make Canada Pension Plan/Quebec Pension Plan payments on self-employed earnings or pensionable earnings for the year
- want to access employment insurance special benefits for self-employed persons
- received a demand from us to file a return
You also need to file a return if you are claiming an income tax refund, a refundable tax credit, a GST/HST credit, or the Canada Child Benefit. You should also file a return if you are entitled to receive provincial tax credits.
The list above does not include every situation where you may have to file. If you are not sure whether you have to file, call 1-800-959-5525.
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Llc Vs Sole Proprietorship
A sole proprietor has total personal liability for their organization. The owner can use private funds to offset business loans and expenses. Even when you sell the business, you are still responsible for the debt incurred during your tenure as the business owner.
In case of death, the deceaseds estate is used to settle all business deficits before its remainder is handed over to successors.
Additionally, in a proprietorship, the owner is liable for business legal issues. For example, when their company is in debt, the proprietor must first file for personal bankruptcy after liquidating business assets.
Only then can they request a discharge from the remaining business debt. This is where LLCs have the upper hand in the LLC vs. sole proprietorship battle:
LLC owners have limited liability protection because the organization is a separate legal entity. Both single-member and partner organizations get their personal assets shielded from liabilities relating to the company. However, in certain conditions, multiple LCC owners shoulder the companys liabilities:
- An owner participates in fraudulent activities or other unlawful business ventures.
- An owner participates in legal ventures that infringe on the distinction between personal and business transactions. For instance, when they co-sign or secure a business loan.
- An owner absconds their fiduciary duty for personal gain.
Sole Proprietor Partnership Llc Which Business Entity Is Right For Me
Whether you, and your business associates, are forming alocal coffee shop or the next big Silicon Valley tech company, mostentrepreneurs will have to decide on the type of operating entity that they willuse for their business venture.
SoleProprietorship
In a sole proprietorship, there is no legal distinctionbetween the business and its sole owner. The owner is personally liable for thebusiness debts, losses, and liabilities. A sole proprietorship is not taxedseparately from its owner. All income and losses are treated similar to a passthrough entity.
GeneralPartnership
A general partnership is formed when a business has two ormore owners. The owners are both jointly and severallyliable for the business debts, losses, and liabilities including for actionsof the other owner. Each owner has the authority to bind the partnership by hisor her actions unless such authority is altered by an agreement among theowners. A general partnership is treated as a pass through entity for taxationpurposes.
LimitedPartnership
Limited LiabilityCompany
Corporation
S Corporation
For assistance in determining the right business entity for you, contact or any of the business lawyers at Tucker Arensberg.
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Only Llcs Can Choose Corporate Tax Status
A key difference between LLCs vs. sole proprietorships is tax flexibility. Only LLC owners can choose how they want their business to be taxed. They can either stick with the defaultpass-through taxationor elect for the LLC to be taxed as an S-corporation or C-corporation. An S-corporation is a pass-through entity. If taxed as a C-corporation, the LLC will pay a corporate income tax at the federal level .
LLCs can sometimes save money by electing corporate tax status. When a company is taxed as a corporation, dividends from the business are usually taxed at a lower rate than ordinary business income. Plus, retained earnings in a corporation arent subject to income tax. In contrast, LLC members cant treat income as dividends and must pay taxes on all profits of the business, whether retained in the company or not. A corporation is also eligible for more tax deductions and credits.
Pros And Cons Of Sole Proprietorships
If youve decided to take on this endeavor by yourself, a sole proprietorship is probably the way to go. The advantage? Complete control.
Unlike an LLC, there arent any complicated legal agreements involved that determine ownership. If youre a sole proprietor, you can run the business however you want.
| The Pros | |
|---|---|
|
Complete control and flexibility to run the business as you see fit |
Personally liable for all business debts, youre all by yourself |
|
Unlimited liability means creditors are more likely to extend credit if needed |
Banks are reluctant to give loans due to higher turnover rates and usually smaller assets |
|
You receive all business profits |
|
|
Smaller amounts of capital make for easier organization |
Since the business relies on one person only, it is harder to raise capital on a long-term basis |
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Appendix : Commonly Used Terms
Business License: Business licenses are permits issued by government agencies that allow individuals or companies to conduct business within the governmentâs geographical jurisdiction. It is the authorization to start a business issued by the local government.
Disregarded Entity: A disregarded entity is a business entity that is not recognized as a separate entity for tax purposes. For example, the default rule under the federal “check-the-box” treasury regulations, is that a single member LLC is considered to be a disregarded entity for tax purposes.
Dissolving, Canceling, or Surrendering an Entity: Business entities doing or transacting business in California or registered with the California Secretary of State can dissolve, surrender, or cancel when they cease operations in California and need to terminate their legal existence here. Refer to FTB PUB 1038, Guide to Dissolve, Surrender or Cancel a California Business Entity, for more information.
Dividend: A dividend is a sum of money paid regularly by a company to its shareholders out of its profits .
Doing Business: A taxpayer is doing or transacting business in California if it actively engages in any transaction for the purpose of financial or pecuniary gain or profit in California. For taxable years beginning on or after January 1, 2011, a taxpayer is also doing business in California if any of the following conditions are satisfied:
Key Features Of A Limited Partnership
- A limited partnership is a flexible form of business and relatively easy to set up.
- A limited partnership allows for more than one owner, unlike a sole proprietorship.
- A limited partnership involves two or more people who agree to create a business and share in its profits and losses.
- The partners decide the structure of the entity, the allocation of profits and losses, and the timing and amount of distributions.
- The general partner is responsible for managing the business affairs.
- The limited partner typically provides only capital, such as cash, to the partnership.
- Each general partner assumes full personal liability for the debts and obligations of the partnership.
- The limited partnerâs liability is normally limited to their investment in the partnership.
- A limited partnership exists, subject to limitations imposed by California law, as long as the partners agree it will and as long as there are at least two partners, one of which is a general partner and one of which is a limited partner.
- The limited partnership does not pay income tax.
- A limited partnership pays an annual tax of $800 to California.
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How To End A Limited Partnership
- File California Form 565 for the last taxable year, check the box that indicates that it is a final return, and write “Final” on top of the return.
- File California Form 565 for all delinquent tax years.
- Pay all outstanding tax liabilities, penalties, and interest.
- Publish notice of its dissolution requesting persons with claims against it to present them .
- Dispose of known claims by following the procedures specified in California Corporations Code Section 15908.06.
- File a Certificate of Cancellation with the California Secretary of State.
- Notify all creditors, vendors, suppliers, clients, and employees of its intent to go out of business.
- Close out business checking accounts and credit cards.
- Cancel any licenses, permits, and fictitious business names.
- Consider publishing a statement in a local newspaper of general circulation near the principal place of business that the limited partnership is no longer in business.
- Refer to FTB PUB 1038, Guide to Dissolve, Surrender, or Cancel a California Business Entity for more information on how to cancel a limited partnership.
How Do I Form An Llc
You create an LLC by filing paperwork with your state and paying a filing fee. Visit the website for your states secretary of state or other agency in charge of business filings for information, forms, and instructions specific to your state. You can also form an LLC with the assistance of an accountant, lawyer or online business formation company.
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Sole Proprietorship Advantages Over An Llc
In a nutshell, starting a sole proprietorship is simpler, less expensive, and less complicated than starting an LLC. One simplification that sole proprietorship offers is that you dont need to separate your business and personal finances by keeping separate bank accounts. If you plan on taking tax deductions based on business expenses, it might be easier to keep your finances separate for tracking purposes, but you are not required to do so by law. You do, however, need to keep accurate financial records for your business, including business income and expenses, in case you are audited by the IRS.
With an LLC on the other hand, by law you must keep separate accounts for business and personal in order to maintain LLC status and the personal liability protection that it affords you. If you mingle your business and personal accounts, then you could lose your limited liability protection. If debt collection or a lawsuit lands you in court, a judge could rule your LLC null and void if you mingle personal and business assets, in which case you lose all liability protection and your personal assets could be used to pay debts or settle legal claims.
Another advantage provided by the simplicity of the sole proprietorship is that you are not required to register your business name if its one and the same as your personal name. If you choose a business name other than your personal name, then you should register your Doing Business As name with your state.
Should I Form An Llc Or Sole Proprietorship
Depending on your business, it will be beneficial to create either an LLC or a sole proprietorship. A sole proprietorship is best suited to small businesses with low risk and low profits. The business will not have a wide range of customers but rather a small, dedicated group. Sole proprietorships usually start as hobbies and become a form of business. The reasons to start an LLC would be the opposite of the reasons above. The business is associated with some risks, the possibility for very large profits, a large customer base, and in a position to benefit from certain tax structures.
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What Is The Difference Between A Sole Proprietor And An Llc
A sole proprietorship is an unincorporated business whose identity is attached to its owner theres no distinction between the proprietor and organization. Your personal and business responsibilities – assets, expenses, and liabilities – are one and the same.
For example, you would be paying your business levies under your personal tax returns. As the name suggests, the proprietor is solely responsible for fulfilling business obligations and paying any potential debt.
On the other hand, an LLC is a business entity with a legal identity different from its owner. The owners have no legal obligations to the organization and, most importantly, theres a distinction between business and personal assets.
How To Form A Corporation
The type of corporation you form will affect the administration and operation of the corporation and the type of documents that must be filed with the Secretary of State. The Secretary of State will assign a 7-digit filing number and the date of incorporation. Keep this filing number and date for your tax records. Contact the California Secretary of State at 916-657-5448 or go to sos.ca.gov for more information.
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How To End A General Partnership
- File California Form 565 for all required tax years and pay all outstanding tax liabilities, penalties, and interest.
- If the general partnership filed a Statement of Partnership Authority with the Secretary of State, it should complete a Statement of Dissolution and file it with the Secretary of State. This will put the public on notice that the partnership has been dissolved.
- Notify all creditors, vendors, suppliers, clients, and employees of the general partnershipâs intent to go out of business.
- Close out business checking account and credit cards.
- Cancel any licenses, permits, and fictitious business names.
- Consider publishing a statement in a local newspaper of general circulation near the general partnershipâs principal place of business that it is no longer in business.
Key Features Of An Llc
- An LLC may have one or more owners, and may have different classes of owners.
- An LLC may be owned by any combination of individuals or business entities.
- An LLC may not be formed under state civil law to conduct a business that requires a professional license to operate, for example, a lawyer may not form an LLC. However, there may be certain exceptions to this rule.
- An LLC may be taxable as a sole proprietorship, partnership, C corporation, or S corporation.
- An LLC that is taxable as a partnership can achieve both conduit tax treatment and limited liability protection under civil law.
- An LLC taxable as a partnership does not have the ownership restrictions that apply to entities taxable as S corporations.
- If the LLC has a single member, it will be disregarded as separate from its owner, and will be treated as a sole proprietorship or a division of its owner, unless it elects to be taxable as a corporation.
- In general, all the owners are shielded from individual liability for debts and obligations of the LLC.
- Forming and maintaining an LLC may be simpler and faster than forming and maintaining a civil law corporation.
- An LLC is typically managed by all its members, unless the members agree to have a manager handle the LLCâs business affairs.
- An LLCâs life is perpetual in nature. However, the members may agree to a date or event of termination.
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Advantages And Disadvantages Of A Sole Proprietorship
There are “pros and cons” in having your business structures as a sole proprietorship or a limited liability, but that’s not the complete picture.
The real issue is how best to select a business model depending on a company’s internal factors, like the number of owners, the unique goals of the company, and how the founder wants the company to operate.
You also need to weigh the more logistical elements of structuring a company – how you’ll do it, what it costs, what the tax picture looks like, and how the day-to-day side of the business will be run. Let’s take a look at all of those issues, and see where the upside and downside fall for sole proprietorships and limited liability companies:
