In the United States, a sole proprietor is defined as:
“A business that legally has no separate existence from its owner. Income and losses are taxed on the individual’s personal income tax return.”
It is the easiest kind of business to create. There is no extensive paperwork. As stated above, when it comes to taxes, the owner of the business reports his or her income on a personal tax return. The proprietor only needs to secure any applicable licenses, and he or she is ready to go.
The proprietor also has the option to create a fictitious name for the business. For example, let’s say the proprietor, whom we will name Sue, wants to run a mobile repair service for stranded motorists. Sue doesn’t just want to be “Sue” in the business section of the phone book, so she files a “Certificate of Assumed Name for Sole Proprietorship” to register herself as “The Traveling Wrench.” This is also sometimes referred to as “Doing Business As.”
Pros and Cons
There are many advantages to being a sole proprietor other than ease of business creation. A few of them include:
•No time-consuming shareholders meetings
•Inexpensive startup costs
•Straightforward tax liability
There are, however, significant disadvantages to this kind of business. A partial list includes:
•Being personally responsible for all debts
•Being susceptible to lawsuits personally
•Not being able to sell shares
•Not having any value after the death or incapacitation of the owner
The part about being personally liable for anything unfortunate that happens can be life-destroying. Let’s say our friend Sue accidentally runs over someone on one of her service calls. The family of the person she injured or killed doesn’t have to file suit against the company. They can sue Sue personally, and all of Sue’s personal assets are at risk. Worse, let’s say Sue hires Joe as a second mechanic. Further, let’s say Joe runs over someone. Sue is now personally liable for Joe’s actions.
In the case of an incorporated company or limited-liability corporation, Sue would be protected from personal liability. She might lose the business over her negligence, but she wouldn’t lose everything the way she might if she were operating as a sole proprietorship.
What is an LLC?
If a business grows to the point that it becomes too unwieldy to operate any longer as a sole proprietorship, it’s common for the owner to convert the business to an LLC. For example, an owner who branches out to multiple locations, hires additional staff, or both, would be wise to convert. The paperwork isn’t that much more complicated than the single form for the sole proprietorship. All that’s usually required is to file a request with the IRS for an employment identification number, articles of organization with the applicable state office, and an LLC agreement.
Before becoming a sole proprietor, it would not only be a good idea to consider all of this information but also contact other businessmen and businesswomen for advice and recommendations. Should you feel it necessary, it might also be good to talk with a lawyer whose focus is business law.
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