What Are The Advantages And Disadvantages Of Sole Proprietorship
Under certain circumstances, sole proprietorships offer small advantages and benefits over formal business structures .
Example: A sole proprietorship can be a good way to start out if you are doing business on a small scale or want to try out a low-risk venture to see how successful it will be.
Sole Proprietorship Advantages:
The only advantage to starting a sole proprietorship vs. an LLC is having to spend no money or energy upfront to form a business. This advantage may seem attractive, but it can be costly in the long run.
Sole Proprietorship Disadvantages:
- No Personal Liability Protection. Your personal assets are at risk in the event your business is sued or if it defaults on a debt.
- No Tax Benefits. Sole proprietors pay taxes on their profits and also pay full FICA taxes . When your business becomes profitable, taxes will be expensive.
- Limited Growth Potential. When a business becomes more profitable, risk increases. When risk and profit increase, so does the need for a legal formal business structure.
- Less Credibility and Branding Opportunities. A sole proprietor must invoice, receive payment, open a bank account, and market with their surname unless their state allows them to register and maintain a doing business as name.
To avoid these issues, you can form a limited liability company . An LLC offers many of the same advantages of a sole proprietorship, while also providing asset protection.
You can also use an LLC formation service to register your LLC for you.
Differences With Other Business Types
Sole members of a domestic limited liability company that elect to treat an LLC as a corporation are considered stockholders and are not sole proprietors. The same holds true for sole owners of a corporation. Furthermore, members of an LLC with multiple members are also not considered sole proprietors as they are members of the LLC. See the Business Structures section on the IRS.gov website for further information.
Registering Your Sole Proprietorship
Unlike an LLC or a corporation, you generally don’t have to file any special forms or pay any fees to start working as a sole proprietor. All you have to do is state that your business is a sole proprietorship when you complete the general registration requirements that apply to all new businesses.
Most cities and many counties do require businesses — even tiny home-based sole proprietorships — to register with them and pay at least a minimum tax. In return, your business will receive a business license or tax registration certificate. You may also have to obtain an employer identification number from the IRS , a seller’s license from your state, and a zoning permit from your local planning board.
If you do business under a name different from your own , you usually must register that name — known as a fictitious, or assumed, business name — with your county. For more information on filing and publishing a fictitious business name statement, see Registering Your Business Name.
In practice, lots of businesses are small enough to get away with ignoring these requirements. But if you are caught, you may be subject to back taxes and other penalties.
For more help in deciding on the best legal structure for your business, see LLC or Corporation? How to Choose the Right Form for Your Business, by Anthony Mancuso .
|Take our business formation quiz for help deciding the best structure for your business.|
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What Are The Risks Of Sole Proprietorship
There are a few risks with opting for a sole proprietorship over an LLC . The main risk is that your personal and professional accounts can be linked.
This means if a customer or vendor sues you, they can go after your personal assets like your home and car. An LLC can protect you, but you need to apply for the status and pay annual fees to your state.
Llc Vs Sole Proprietorship: Formation
You might be surprised to learn that theres nothing specific you necessarily need to do to form a sole proprietorship. In fact, you might be operating a sole proprietorship without even knowing it. Any person selling goods and services without a partner is a sole proprietor by default. Depending on where your business is located, you might need to apply for business licenses or zoning permits to legally operate your sole proprietorship. And any business, including a sole proprietorship, that operates under a trade name, needs to apply for a fictitious business name, also known as a DBA or doing business as certificate. However, thats it as far as formation paperwork goes, making sole proprietorships the easiest and least expensive type of business to start.
An LLC might also need to file for business permits and a DBA . But the most important formation document for an LLC is called the articles of organization. This document establishes your LLCs existence and must be filed with the state in which youre operating. The cost to file articles of organization varies by state, but generally ranges between $50 to $200.
» MORE: Business insurance for LLCs
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How To Start A Sole Proprietorship
A sole proprietorship is easy to establish. You dont need to take any legal steps to form this type of business. If you are the only owner and begin conducting business, you automatically become a sole proprietorship. There is no need to formally file paperwork or submit anything at the federal, state, or local level to be recognized as such.
It is important to note, that depending upon where you run your business and what kind of business it is, you may also need to file for business and/or occupancy licenses and permits.
What Is A Sole Proprietorship Definition Types Examples
In this session, we will be discussing what is a sole proprietorship, and also sole proprietorship definition, sole proprietorship meaning, features of sole proprietorship business, types, importance, advantages of sole proprietorship business, disadvantages of sole proprietorship business, sole proprietorship examples.
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Llc Vs Sole Proprietorship: Paperwork And Compliance
The final difference between an LLC vs. sole proprietorship has to do with paperwork and compliance requirements. As we mentioned earlier, a sole proprietorship requires the least amount of paperwork prior to launch. After launch, a sole proprietor only needs to keep up with federal, state, and local taxes. In addition, a sole proprietor might need to renew business permits.
An LLC has more compliance responsibilities. After filing initial articles of organization, LLCs have to file an annual report in many states. An LLC with multiple members has even more responsibilities, such as drafting an operating agreement, issuing membership units, recording transfers of ownership, and holding member meetings. None of these steps are legally required, but are highly recommended for LLCs to preserve liability protection for members. In addition, since an LLC is a registered business entity, dissolving an LLC takes additional paperwork.
Disadvantages Of A Sole Proprietorship
While there are certain advantages that come with starting a sole proprietorship, there are also disadvantages to consider when deciding if a sole proprietorship is right for you. Here are a few potential disadvantages to keep in mind when determining if this type of business is your best choice:
Personally liable for lawsuits: Sole proprietors are personally responsible for all aspects of the company’s financial situation. This means that if the company is in debt and unable to pay lenders, the lenders can bring lawsuits against the individual who owns the sole proprietorship. If these lawsuits are settled in favor of the lenders, the business owner will be held personally responsible to pay for the debts.
Limited options for raising capital: Whereas other types of companies can sell an interest in the business to raise capital, a sole proprietorship cannot. This can limit a sole proprietor’s ability to bring in capital when it is needed.
Higher taxes: Individuals who own sole proprietorships are responsible for paying the income tax and self-employment tax for the business’s income. This can be a hefty fee if the sole proprietorship is successful.
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Llc Vs Sole Proprietorship: Legal Protection
In a sole proprietorship, theres no legal separation between the business and the owner. The owner is personally responsible for the businesss debts. If the business goes bankrupt, the sole proprietor has to file for personal bankruptcy, and both personal and business debts will be included in the bankruptcy proceedings. In addition, someone who sues a sole proprietorship can name the owner personally in the lawsuit and come after their personal assets.
One of the best ways to protect your personal assets is to form an LLC. Since an LLC is a legally separate entity from the owner, the owner isnt personally liable for the businesss obligations. If the business fails, the owners can file for business bankruptcy, and they dont have to pay business creditors out of their own pockets. And with some exceptions, someone who sues an LLC cant personally sue the owners. Of course, owners in an LLC can be held personally liable for fraud, negligence, or personally guaranteed debts. Theres no business structure that offers absolute protection for owners for liabilities connected to the business.
Personal Liability For Business Debt
Neither sole proprietorships nor partnerships shield the owners from the obligations of the business. Creditors can go after your personal assets like your home, bank account, and your car to pay for the debts of the business. The law does not distinguish between you and your business. When the business owns property, so do you. Bringing a lawsuit against a partnership or a sole proprietorship is the same as suing the owners.
When you form a partnership, you could be personally responsible for anything your partner does in the course of running the business. However, you will not be responsible for all of your partner’s actions. For example, if your partner caused a car accident while on vacation, your personal assets would not be on the line to pay for the damage caused by the accident. However, if your business is a delivery service, and your partner were to crash the business truck while on a delivery to a customer, you might be personally liable.
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Why You Should Form An Llc
There are several benefits to starting an LLC that may or may not matter to a business owner. But, regardless of any other factor, a business owner needs to form an LLC when they start to earn a profit or carry risk.
This is because profit and risk open the door to liability. A sole proprietor’s personal assets are completely exposed to creditors and lawsuits because legally, the sole proprietor is the business. In an LLC, the business can be legally separate from the business owner.
- Protect your savings, car, and house
- Increase your peace of mind
- Protect your privacy
Determining If A Sole Proprietorship Is Right For You
When establishing a business, there are several structures to choose from. If youre considering becoming a sole proprietor, its important to take the following points into consideration:
Taxes: Your business structure affects how much tax you pay. As a sole proprietor, you claim profits on your personal tax return. However, most business types, such as corporations, are subject to double taxation, which sole proprietors are protected from.
Liability: Sole proprietors take personal responsibility for all of their financial decisions because their business is not considered a separate legal entity. However, business owners of LLCs and partnerships are protected from personal liability.
Cost: Registering as a sole proprietorship is the cheapest type of business to establish. This is highly beneficial for small business owners with limited funds.
Investors: If you plan to work with investors, a sole proprietorship may not be the best choice because business laws dont allow external parties to fund this type of venture. However, you can always start off as a sole proprietorship and expand into another business structure at a later point.
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Limitations Of A Sole Proprietorship
If you want to start your own business and have not sufficient money, sole proprietorship is right for you because you do not need much money and legal formalities to start business. It is very easiest and least expensive form of business to set up and operate. You can get various benefits of sole proprietorship which gives you an identity in the home based or small business.
The Business Is Harder To Sell
Because the business is all yoursand may give off the impression that you are closely intertwined to the businesss successit can be harder to sell a sole proprietorship. This may be especially true if the business is run under your personal name and you havent taken steps to establish a brand identity for your business that isnt too tied to your personal identity.
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Merits Of Sole Proprietorship
- Quick decision and prompt action
- Better control
- Least record keeping
- Close personal relation
A sole proprietorship is among the oldest and simplest business forms wherein, only one man heads the entire show. Some common examples of sole proprietorship business are grocery shop, chemist shops, beauty parlours, fabrication units and so on.
How Do You Start A Sole Proprietorship
To start a sole proprietorship you need to for the most part just start your business. It does not require registering with your state. It is recommended to come up with a company name and then apply for a permit or license with your city and state if needed. If you plan to hire employees then you will need an employee identification number from the IRS and if you are going to sell taxable products you will need to register with your state.
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Paying Taxes On Business Income
In the eyes of the law, a sole proprietorship is not legally separate from the person who owns it. Instead it is considered a pass-through entity for tax purposes. The fact that a sole proprietorship and its owner are one and the same means that a sole proprietor simply reports all business income or losses on his or her individual income tax return — IRS Form 1040, with Schedule C attached.
As a sole proprietor, you’ll have to take responsibility for withholding and paying all income taxes — something an employer would normally do for you. This means you’ll have to pay a “self-employment” tax, which consists of contributions to Social Security and Medicare, and pay estimated taxes throughout the year. For more, including information on the 20% tax deduction for pass-through business entities, see How Sole Proprietors Are Taxed.
Final Words: Sole Proprietorship Is One Guys Dream Coming True
Proprietorship, also called sole trader ship, is the oldest form of business ownership in the world.
In a proprietorship, the enterprise is owned and controlled by one person the master of his/her show he/she sows reap and harvest the outputs of the effort manages the business on his own.
If necessary, he/she may take the help of his/her family members, relatives, and employ some employees.
Proprietorship is the simplest and easiest to form. It does not require legal recognition and attendant formalities. The one-man control is the best in the world if that man is big enough to manage everything.
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Learn And Study What Is Sole Proprietorship Meaning And Definition
A sole proprietor may use a trading name or business name other than his, her, or its legal name. They may have to legally trademark their business name if it differs from their own legal name. The process varying depending upon the country of residence. The sole trader receives all profits and has unlimited responsibility for all losses and debts. The proprietor owns every asset of the business, and all debts of the business are the proprietors. It is a sole proprietorship in contrast with partnerships .
Meaning of Sole Proprietorship:
A sole proprietorship, also known as a sole trader or a proprietorship, is an unincorporated business with a single owner. Who pays personal income tax on profits earned from the business. With little government regulation, a sole proprietorship is the simplest business to set up or take apart. Making sole proprietorships popular among individual self-contractors, consultants, or small business owners. Many sole proprietors do business under their own names because creating a separate business or trade name isnt necessary. Also learn the Definition, Importance, and Affected Factors of Manpower Planning.
Definition of Sole Proprietorship:
Also, A sole proprietorship is an unincorporated business owned by one individual, making it the simplest form of business to start and operate. Over 20 million sole proprietorships are operating in the United States and Canada, making it by far the most popular form of business ownership.