Sole Proprietorship Law and Legal Definition

A majority of the small businesses in the United States are operated as sole proprietorships. This type of business organization is the simplest and is the form usually chosen by the one-person business, in which the owner and worker are the same person (although sole proprietorships can have employees). A sole proprietorship is not a separate entity from the owner-a sole proprietor directly owns the business and is directly responsible for its debts. Sole proprietorships are suitable for a business where personal liability isn't a big worry -- for example, a small service business in which you are unlikely to be sued and for which you won't be borrowing much money for inventory or other costs.

FORMATION

You can start a sole proprietorship simply by beginning to conduct your business. You should open a separate bank account to keep track of your business's finances and keep records of all of the expenses and revenues connected with running the business. Depending on local requirements, you may need to file a "Doing Businesss As (DBA)" or "Fictitious Name" statement and publish notice of your name in a local newspaper. Care should be taken in selecting a name to ensure it is not the same or similar to the name of another business. Also, note that many states prohibit using the words "incorporated," 'Inc.," "Corporation," "Company" or "Co." unless your business is a corporation. Any licenses or permits required must be obtained, such as business licenses, zoning occupancy permits and tax registrations, depending on the nature of the business. You may also have to obtain an employer identification number from the IRS (if you have employees).

MANAGEMENT

Generally, the owner (sole proprietor) has total management and control over the company. However, the drawback is that the owner is at risk for personal liability incurred through the acts of the owner’s agents or employees. A sole proprietor may hire employees to help manage the business, but the owner will have legal responsibility for the decisions made by the employees and ultimate control over the business.

Insurance may be purchased to cover many of the risks of running a sole proprietorship, but will not cover loss of profits in general.

TAXATION

The owner reports business income or losses on his or her individual income tax return. A sole proprietor is taxed on all income from the business at applicable individual tax rates. The business income, and allowable business expenses, are reflected on the individual tax return. All business income is taxed to the owner in the year the business receives it, whether or not the owner removes the money from the business. No separate federal income tax return is required of the sole proprietor. However, a proprietor must pay self-employment tax on the business income.

DURATION

The sole proprietorship remains in existence for as long as the owner is willing or able to stay in business. When the owner dies, the sole proprietorship no longer exists. The assets and liabilities of the business become part of the owner's estate. A sole proprietor can freely transfer a business by selling all or a portion of the assets of the business.

ADVANTAGES

  • Is inexpensive to start.
  • Is simple to run. With the exception of complying with any applicable licensing requirements, there are no formalities required of a sole proprietorship (except that some states require that the owner file a fictitious business name statement and publish notice).
  • Has no double taxation on profits.
  • Transferability: The owner can sell the business as he or she pleases.

DISADVANTAGES

  • Owner has unlimited personal liability for business liabilities. In a sole proprietorship, the owner is personally liable for the company, thus placing his or her entire personal assets and wealth at risk. If an owner is married, that owner puts the community property at risk as well.
  • Business has unlimited liability for owner's personal liabilities.
  • Ownership is limited to one person.