What Is a Sole Proprietorship and How Does It Work?

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The sole proprietorship is the easiest type of business to run. A sole proprietorship is not a legal body in and of itself. It actually refers to the owner of a company who is personally liable for its debts. A sole proprietorship may do business under its owner’s name or under a fictitious name, such as Nancy’s Nail Salon. The fictitious name is merely a trade name; it does not create a separate legal entity from the sole proprietor.

Understanding the Definition of a Sole Proprietorship

Because of its simplicity, ease of setup, and low cost, the sole proprietorship is a common business structure. A sole proprietor only needs to register his or her name and obtain local licences before going into business. A significant drawback is that a sole proprietorship’s owner is directly responsible for all of the company’s debts. In the event that a sole proprietorship runs into financial difficulties, creditors can file a lawsuit against the business owner. If such lawsuits are successful, the business owner will be forced to pay the debts out of his or her own pocket.

Since the sole proprietorship has no separate legal identity, the owner of a sole proprietorship usually signs contracts in his or her own name. Even if the company has a false name, the sole proprietor will usually make customers write checks in his or her name. Partnerships, LLCs, and companies are unable to mix personal and company property and assets, which is something that sole proprietors often do. Bank accounts for sole proprietorships are often in the owner’s name. Sole proprietors are exempt from the more complicated business forms’ formalities such as voting and meetings. Sole proprietorships have the ability to file claims (and be sued) under their own name. Many companies start out as sole proprietorships and progress to more complex business structures as they grow.

Since a sole proprietorship and its holders are indistinguishable, sole proprietorship taxation is straightforward. A sole proprietorship’s income is the income gained by its owner. Filling out and filing a Schedule C along with the regular Form 1040 is how a sole proprietor registers sole proprietorship revenue, losses, and expenses. Your gains and losses are first reported on Schedule C, a tax form that is filed with your 1040. Then you move the “bottom-line number” from Schedule C to your personal tax return. This is appealing because any business losses you incur may be offset by revenue from other sources.

Particular Points to Consider

You must also file a Schedule SE with your Form 1040 if you are a sole proprietor. Schedule SE is used to figure out how much self-employment tax you owe. You may not have to pay unemployment tax on yourself, but you must pay unemployment tax on any workers who work for your company. Of instance, if the company suffers a setback, you won’t be eligible for unemployment benefits.

All debts owed by a sole proprietorship company are directly responsible to the sole proprietor. Let’s take a closer look at this because the possible liability is concerning. Assume a sole proprietor borrows money to keep the business running, but the company loses its biggest client, goes out of business, and is unable to repay the loan. The sole proprietor is responsible for the entire loan amount, which could wipe out all of her personal assets.

Consider the following scenario: the sole proprietor (or one of her employees) is involved in a business-related accident in which someone is injured or killed. The sole proprietor owner and her personal properties, such as her bank account, retirement plans, and even her estate, can be sued in the ensuing negligence case.

Before deciding on a sole proprietorship as your business structure, carefully consider the preceding paragraphs. Accidents do occur, and companies fail on a regular basis. Any sole proprietorship that encounters such adversity is likely to rapidly transform into a nightmare for its owner.

A sole proprietor may file a lawsuit in his own name if he is wronged by another person. In the event that a corporation or LLC is wronged by another individual, the group must file a lawsuit in its own name.

A sole proprietorship has the following advantages:

Owners can form a sole proprietorship quickly, comfortably, and affordably.
There are few, if any, ongoing formalities for sole proprietorships.
A sole proprietor would not have to pay self-employment fee (although he or she must pay unemployment tax on employees).
Owners have complete freedom to combine business and personal properties.

A sole proprietorship has the following drawbacks:

Owners bear unlimited personal responsibility for the company’s debts, losses, and liabilities. Owners are unable to raise capital by selling a stake in the business. Sole proprietorships seldom survive their owners’ death or incapacity, and therefore have little worth.
The ease with which a sole proprietorship may be established is one of its best features. There isn’t anything more to it than purchasing and selling products and services. In reality, forming a sole proprietorship requires no formal filing or event; it is a status that emerges naturally from one’s business operation.

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