Formation, LLC, Corps Creating a Sole Proprietorship, the Simplest Business Entity

When an individual person owns and operates a business alone, that business is called a "Sole Proprietorship." It is the easiest form of business to set up and, by far, the least costly and with virtually no legal formalities.

Using Fictitious Business Names or Trade Names

A sole proprietorship can operate under the name of the business owner or under an assumed or fictitious name, which is also known as the "trade name" of the business. The owner may wish to register an official name for their business that is different than his or her own name, e.g. "Acme Car Repair Service." If a fictitious business name is used, it is usually required to be registered within the county or city in which the business owner lives. Examples of the types of businesses which use fictitious business names include freelance photographers, single owner hair salons, construction companies who take jobs on contract, writers, sales people who work for commission, etc. When conducting business, a sole proprietor can both pay and receive bank checks that use the name of the business owner and not the name of the business. Unlike corporate law, a sole proprietor may co-mingle business money and personal money in a single bank account in their name.

Business License Requirements

A sole proprietor may need to obtain a business license for certain types of work, although this bears no relation to the formation of a sole proprietorship in itself. A business that offers a product for sale may require a seller's license from the state and may need a zoning permit from a local planning board. People who want to start such a business should first check with their city, county and state for more specifics on these few requirements. It is frequently advisable to consult with an experienced business lawyer who may be familiar with all the rules, regulations and requirements that are necessary in order to operate a specialized business.

Sole Proprietors Have Personal Liability – Consider a Small Corporation

Any person starting a small business should be aware of the benefits as well as the legal risks involved in running a sole proprietorship. When a sole proprietor signs contracts for his or her business, that business owner is personally responsible to fulfill the contract. The business and the person running the business are considered the same legal entity -- unlike corporations which are considered a separate legal "person" apart from the business owner(s). As a result, a sole proprietor is personal liable for all the debts of the business – including loan payments – regardless of whether the business fails. If someone is injured as a result of negligence while physically on the business property, the plaintiff can sue the business owner personally for any damages suffered. A sole proprietor is held personally liable for the cost of defending and losing potential lawsuits. An award for damages against the sole proprietorship can be executed against the business owner's home, bank account, retirement account, investments and personal assets. As a result of the significant risk of personal liability, most sole proprietors find it more practical to eventually convert a sole proprietorship into another business form, usually a small corporation like a Limited Liability Corporation (LLC). As opposed to sole proprietorships, corporations such as an LLC will protect the owner from personal liability.

Taxes and the Sole Proprietor

Paying taxes for sole proprietorships is very simple. The owner reports income received by the business as earned income by the owner. The Schedule C tax form is filled out and filed when a taxpayer files the standard Form 1040 income tax return. The amount on the bottom line of the Schedule C is simply transferred over to the appropriate line on the personal tax return of the owner. If the business has hired employees, Schedule SE must also be filed along with Form 1040 and Schedule C. This will indicate how much self employment taxes you may owe along with any unemployment taxes that are required for employees. Furthermore, a Tax Payer ID number is required when you have hired employees. Sole proprietors must also contribute to their own Social Security and Medicare taxes. Estimated self employment income taxes should be paid throughout the year by sole proprietors. There are some tax benefits to being a sole proprietor - any business losses incurred can be used to offset earned income amounts from other sources not related to the business.

Summary of Advantages of Sole Proprietorships

  • Very easy to create and at a very low cost
  • No business formalities to follow, no company bylaws, articles, etc.
  • Sole proprietors do not need to pay unemployment taxes for themselves (only for other employees, as and if required)
  • Business proceeds can be placed into the owner's personal bank account, no requirement to be kept separately in a special business account
  • Business losses can be used to reduce personal income taxes owed

Summary of Disadvantages of Sole Proprietorships

  • The owner is personally liable for any debts of the business and can be sued personally (personal assets are at risk)
  • Unable to sell shares of the business to raise extra revenues for funding
  • The business will essentially terminate when the sole proprietor passes away or becomes disabled or incompetent
Business, Corporate & Nonprofit Law
Sole Proprietorship
About author
Michael Wechsler
Michael M. Wechsler is an experienced attorney, founder of TheLaw.com, A. Research Scholar at Columbia Business School and of-counsel to Kaplan, Williams & Graffeo, LLC. He was also an SVP and chief Internet strategist at Zedge.net and legal consultant at Kroll Ontrack, a leading service e-discovery and computer forensics service provider.

Comments

There are no comments to display.

Article information

Author
Michael Wechsler
Article read time
4 min read
Views
2,897
Last update

More in Business & Nonprofit Law

More from Michael Wechsler

Share this article

Back
Top