When an individual thinks about forming a business, it is often in conjunction with a business partner or team and requires the development of some type of partnership or corporate formation. But what happens when you want to form a business of which you are the sole owner? This is called a sole proprietorship, and it is one of the easiest forms of business formation.
Creating a Sole Proprietorship
If you are self-employed, chances are you may have created a sole proprietorship without even knowing it. Individuals who are in business for themselves, such as artists, writers, photographers, or designers, are typically automatic sole proprietors. So are individuals who work as independent contractors for other entities, or salespersons who work entirely off commissions.
This is because, unlike a limited liability partnership or a corporation, sole proprietors are not required to register for any type of special status with the state, or file any particular paperwork. Instead, all you must do is identify yourself as a sole proprietor when you register your business with the state, as all businesses must do. This occurs when you apply for a business license or tax registration. As a sole proprietor, you may also need other official documentation from the state, including possible licenses to sell, if applicable, or particular zoning permits. If this is news to you, as an independent business owner, you are not alone. Many sole proprietors of small businesses are not aware of registration requirements. However, it is important to know that, should you be caught, penalties can be imposed for failure to register.
Liability and the Sole Proprietor
Unlike limited liability partnerships and corporations, sole proprietors do have personal liability for the debts of their business. This means that any assets you own as an individual, such as a home, car, or retirement account, can become subject to creditors if your business does not pay its debts or is subject to a judgment by a court after a lawsuit. For instance, if your business takes out a loan of $10,000, but, when it comes due, your business only has $5,000 in assets, the bank or creditor can come after you for the remaining $5,000 and may take it from your personal bank accounts. This is a very serious ramification of operating as a sole proprietorship and is a factor to consider when contemplating whether to operate as a corporation or a sole proprietorship. While corporate status comes with a great deal more paperwork and requirements, it also protects you and your loved ones from financial risk if something goes wrong with your business.
Sole Proprietorships and Taxes
Another factor to consider in business formation is how taxes will be treated. For instance, certain forms of corporations allow business owners to avoid double taxation on certain business profits. For sole proprietors, there is no separation between the taxes of the sole proprietorship and the taxes of the owner. Instead, all business profits are treated as the income of the owner. This makes taxation relatively straightforward, since business income is simply reported on one’s personal taxes. While this may seem odd, it is grounded in the same reasoning as personal liability for debts of the business. The sole proprietorship and the owner are considered one and the same.