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The Sole Proprietorship

A sole proprietorship, as the name suggests, is a business with one owner. Of the four types of business organizations, it is probably the most common. A business organized as a sole proprietorship is not separate from its owner, but merely a different name with which the owner represents him/herself to the public. The owner is the business and the business is the owner. They're inseparable.

Advantages
Since they have few legal requirements, sole proprietorships are easy to form and operate. They can also be more affordable since no legal documents need to be filed in most cases. Basically, all you have to do to organize a sole proprietorship is get a business license and begin operations.

Disadvantages
Although the sole proprietorship does have the advantage of simplicity, the negative aspects steer most entrepreneurs away from this form of business organization. The disadvantages of a sole proprietorship stem from its very nature—the business and the business owner are inseparable. This leads to three potential problems.

Unlimited liability – Since the owner and the business are inseparable, whoever sues the business actually sues the owner personally. A single lawsuit can financially ruin a sole proprietorship and its owner because the owner’s personal property can be taken to satisfy judgments against “the business.” The owner’s personal exposure is unlimited.

Responsible for business obligations – The business owner is personally liable for the debts of the company, and unfortunately, personal assets like cars, savings, and homes can be taken to pay company obligations.

No tax benefits – Owners can lose some lucrative tax free fringe benefits because they cannot participate in company funded employee benefit plans like medical insurance and retirement plans. Since the owner is the business, he/she cannot be an employee, and therefore can’t participate in “employee” benefit plans. (Some owners get around this by hiring their spouse as an employee, and the spouse participates in the employee benefit plans.)

Taxes
Since the owner and the business are the same entity for tax reporting purposes, a sole proprietorship is known as a pass-through entity. This means that all business income and expenses are passed through to, and filed as part of the owner’s personal return. If there is a business loss, the owner will enjoy a deduction to offset personal (paycheck) income. However, if the business makes a profit, the owner must pay any taxes due.

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