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Sunday, December 21, 2008

The Sole Proprietorship

A sole proprietorship is the simplest form of business to start. Ordinarily, all you need to do is start operating as a business under your own name (or a fictitious name - a d/b/a) and Social Security number, obtain any required licenses or permits, and you're in business.

But there are some distinct disadvantages to operating as a sole proprietorship, which you should consider when determining if this business form is right for you.

By definition, a sole proprietorship has only one owner. If you have a business partner, you may be a partnership or choose a different business form, but you cannot operate as a sole proprietorship.

Selecting a Name

In most jurisdictions you may do business under your own name. However, if you wish to use a variation of your name or a completely different business name, you may register a d/b/a ("doing business as..."), such that you may lawfully conduct business under that fictitious name.Usually, d/b/a's are filed at the County level, but in some cases they may be filed at the state level. When you register a d/b/a, the clerk who processes your application will check to make sure that nobody else in their registry is using the same name you have requested. They will also maintain a record of your real identity for anybody who wishes to find out who is operating under the selected business name.

Unlimited Liability

The biggest potential downside of operating as a sole proprietorship is the lack of protection from personal liability. Most businesses can operate under alternate forms, such as corporations or LLC's, which provide considerable protection of your personal assets in the event of litigation or if your creditors are seeking to collect business debts, such that they can ordinarily only reach the assets of the business entity. A sole proprietorship is not legally distinct from its owner. If you operate as a sole proprietorship, your personal assets may be subject to those claims.

If you are engaged in a business which has a significant chance of being the subject of litigation, you will want to make sure that you carry adequate insurance, and will likely wish to choose a business form which shields you from personal liability in the event of a lawsuit. By way of example, if you are giving piano lessons, you probably have a low risk of liability; but if you are giving swimming lessons or horseback riding lessons, a small mistake by you or a student can result in a significant liability to your business.


Another potential downside of a sole proprietorship is that any income to the business is treated as income to the business owner, and all income is reported on your individual tax return, and is taxed in the year it is received. With other corporate forms, it may be possible for the business to have its own income (and to file its own income tax return), and it may be possible to defer income to a different tax year. With a sole proprietorship, even the money you leave in your business bank account is taxed in the year it is earned, even if you are saving it to pay for business expenses in the coming year. It is important to consider tax consequences when selecting the form of your business.

The income you earn from your sole proprietorship remains subject to income and "self employment tax" (your Medicare and Social Security contributions), and you will be responsible to pay those taxes at the end of the year. In most cases, you will also be required to make quarterly payments of your estimated tax liability, to both the state and to the federal government.

You may deduct your legitimate business expenses when you calculate your taxes, and you may report losses from your sole proprietorship on your income tax return.

Should You Incorporate?

As previously noted, if the type of business you are operating has the potential for incurring significant liability and you wish to shield your personal assets from lawsuits and creditors, you may wish to consider a business form which protects your assets. The corporation provides a broad shield against personal liability for business debts.

Also, if you do not wish to have all business income treated as your personal income, or would rather have the business pay taxes on its own income than have that income included on your personal tax return, you may wish to incorporate. While ideally this will lower your overall business taxes, you should be aware that incorporation may increase the total tax obligations of a business even with no change in income, and you will want to calculate any effect on your tax liabilities before incorporating your sole proprietorship. Also, even if you have tax savings, you will want to consider the costs and burdens of maintaining a corporation as compared to continuing as a sole proprietorship.

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