Sole Proprietorship
Tony Robinson
There are several forms of organization for a business; the most common for small business is the sole proprietorship. In this article we're going to define the sole proprietorship, and look at the advantages of operating a business in this manner.
In the formation of a sole proprietorship, there is essentially no separation of the business from the owner. There is no legal separation of the business from the individual, and if you operate a sole proprietorship, you are personally responsible for the debts and liabilities of the business. Quite honestly, it's the method chosen by the majority of business owners for this reason: simplicity. There is no need for hiring a lawyer, there's no need for corporate paperwork and fees, and you can be in operation tomorrow, theoretically.
This is a continuation of the entrepreneurial spirit upon which most businesses are founded anyway. The definition of entrepreneur is one who initiates a new enterprise, assuming all the financial risks associated herewith, and undertakes to provide or control its management. The sole proprietorship form of operation is simply a continuation of that risk-taking spirit that inspires so many of us to take the leap into business ownership.
The income of the business is reported with the individual's tax return on the Schedule C, "Profit or Loss from Business" and is attached and made a part of the personal tax return. Although the business information is reported on a separate schedule, all the profit or loss flows through to be reflected on the individuals 1040 or 1040A. This is one of the advantages to operating in this manner; the other advantages would be the freedom to make any decisions the owner deems necessary, without any further input, the flexibility that comes from individual ownership, and the tax benefit that comes if the business shows a loss; it directly affects the personal tax liability of the owner.
What are some of the disadvantages? The biggest would be the fact that the owner is the business, and as such is solely responsible for debts, damages, liability, and operation. This is known as unlimited liability. Other disadvantages are the owner's difficulty in raising capital, and the continuation of the business; if the current owner dies, then a new sole proprietorship is formed, even if it is inherited by a relative. As you can see, sometimes the disadvantages, once the business has reached a certain size, might outweigh the advantages.
Is the sole proprietorship the best way to operate? In some instances, yes. In others, the answer would be no. However, there are several other options of organization formation, such as the S Corporation, the C Corporation, the Partnership or the Limited Liability Corporation; the catch here, is that all these forms of business require the owner or owners to form a legal basis for the business, and generally all members will want to actively participate.
One of the great current incentives to operate a business as a sole proprietorship today, and one in which there is growing interest is the ability to establish certain tax exempt retirement accounts, such as the SEP, or a Self Employed Pension plan. Retirement accounts like these, allow the small business owner to put away a large sum of money tax free, that might be otherwise be treated as taxable profit income. This has been a problematic situation for many of the nations self-employed: how to safe for retirement, without having insurmountable taxes levied on those savings. Well, today thanks to the creativity of our law makers, and many business owners, the sole proprietorship has several retirement options, that the owner can make tax-free contributions each year to save for their retirement.
Now that we've examined many of the advantages and disadvantages of the sole proprietorship, and we've looked at the tax and personal liability issues, we can close with one final thought: the spirit with which many begin their business endeavors cannot be organized into one form of operation, it simply chooses to seize the moment. This is what continues to ensure the success of the small business, in any form.
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