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LEGAL DICTIONARY

Sole Proprietorship

What is a Sole Proprietorship?

A sole proprietorship is a business with only one owner who pays personal income tax on all business earnings. Because a sole proprietorship is easy to establish and dismantle, it is a popular structure for many small businesses, consultants, and independent contractors.

Since a sole proprietor is considered to be self-employed, many sole proprietors do business under their own name. Many sole proprietors will restructure their unincorporated business as a limited liability company (LLC), limited liability partnership (LLP), or corporation if their company expands.

LLC vs. Sole Proprietorship

Although a sole proprietorship is a simple and easy business structure, it is not without risk. The business owner of a sole proprietorship is responsible for all debts and liabilities of the business.

With an LLC, on the other hand, the business is a separate legal entity. That separation means that the LLC’s owners (also called members) are not personally responsible for business debts and liabilities.

The decision to set up a sole proprietorship or an LLC depends mainly on the type of business. A sole proprietorship is often the best structure for small businesses with low risk and a small customer base.

Businesses with higher risk potential and a more extensive customer base will benefit from the LLC structure.

Pros and Cons of a Sole Proprietorship

A sole proprietorship may not be the best business configuration in all cases. For example, there is no distinction between the business and the business owner in the case of a sole proprietorship. Here are the advantages and disadvantages of this structure:

Pros of a sole proprietorship

  • They are inexpensive to set up. Less time, money, and paperwork are required to establish a sole proprietorship than other business structures.
  • Easy tax preparation. Sole proprietors must complete Form 1040 and Schedule C at tax time. No employer identification number (EIN) is needed from the IRS.
  • Simplified banking. Personal and business accounts do not need to be separated in a sole proprietorship.

Cons of a sole proprietorship

  • Higher personal liability. The business owner is personally responsible for all business obligations and debts.
  • More difficult to raise capital. Banks are often hesitant to lend to sole proprietorships, and investors may see your business as a risk.

How to Start a Sole Proprietorship

Sole proprietorships are generally not difficult to start. In fact, no formal steps are required to launch a sole proprietorship. In many cases, all you need to do is start your business. However, if your business requires a license or if you plan to sell taxable products, you will need to register with your state.

To file taxes as a sole proprietor, you need to complete IRS Form 1040 for individual taxes as well as Schedule C, which details the profits and loss of your business. The tax amount you owe is based on the combined income of both forms. By filing taxes quarterly, sole proprietors can avoid possible fees and penalties and one sizeable end-of-year tax assessment.

How to Convert a Sole Proprietorship into an LLC

If your business expands and you wish to convert a sole proprietorship into an LLC, you will need to file articles of organization with your Secretary of State office.

Depending on state laws, you may have to refile your or even cancel your name or your Doing Business As (DBA). Also, you will need to apply for an EIN from the IRS in order to file your taxes as an LLC.

More resources:

US Small Business Association - Choose Your Structure

IRS - Sole Proprietorships

What is a Sole Proprietorship?

A sole proprietorship is a business with only one owner who pays personal income tax on all business earnings. Because a sole proprietorship is easy to establish and dismantle, it is a popular structure for many small businesses, consultants, and independent contractors.

Since a sole proprietor is considered to be self-employed, many sole proprietors do business under their own name. Many sole proprietors will restructure their unincorporated business as a limited liability company (LLC), limited liability partnership (LLP), or corporation if their company expands.

LLC vs. Sole Proprietorship

Although a sole proprietorship is a simple and easy business structure, it is not without risk. The business owner of a sole proprietorship is responsible for all debts and liabilities of the business.

With an LLC, on the other hand, the business is a separate legal entity. That separation means that the LLC’s owners (also called members) are not personally responsible for business debts and liabilities.

The decision to set up a sole proprietorship or an LLC depends mainly on the type of business. A sole proprietorship is often the best structure for small businesses with low risk and a small customer base.

Businesses with higher risk potential and a more extensive customer base will benefit from the LLC structure.

Pros and Cons of a Sole Proprietorship

A sole proprietorship may not be the best business configuration in all cases. For example, there is no distinction between the business and the business owner in the case of a sole proprietorship. Here are the advantages and disadvantages of this structure:

Pros of a sole proprietorship

  • They are inexpensive to set up. Less time, money, and paperwork are required to establish a sole proprietorship than other business structures.
  • Easy tax preparation. Sole proprietors must complete Form 1040 and Schedule C at tax time. No employer identification number (EIN) is needed from the IRS.
  • Simplified banking. Personal and business accounts do not need to be separated in a sole proprietorship.

Cons of a sole proprietorship

  • Higher personal liability. The business owner is personally responsible for all business obligations and debts.
  • More difficult to raise capital. Banks are often hesitant to lend to sole proprietorships, and investors may see your business as a risk.

How to Start a Sole Proprietorship

Sole proprietorships are generally not difficult to start. In fact, no formal steps are required to launch a sole proprietorship. In many cases, all you need to do is start your business. However, if your business requires a license or if you plan to sell taxable products, you will need to register with your state.

To file taxes as a sole proprietor, you need to complete IRS Form 1040 for individual taxes as well as Schedule C, which details the profits and loss of your business. The tax amount you owe is based on the combined income of both forms. By filing taxes quarterly, sole proprietors can avoid possible fees and penalties and one sizeable end-of-year tax assessment.

How to Convert a Sole Proprietorship into an LLC

If your business expands and you wish to convert a sole proprietorship into an LLC, you will need to file articles of organization with your Secretary of State office.

Depending on state laws, you may have to refile your or even cancel your name or your Doing Business As (DBA). Also, you will need to apply for an EIN from the IRS in order to file your taxes as an LLC.

More resources:

US Small Business Association - Choose Your Structure

IRS - Sole Proprietorships