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Sole Proprietorship as a Form of Business

Sole Proprietorships are Easy to Set-up

Sole Proprietorships are the easiest form of business to start and in many respects the easiest form of business to stop. Since more than 90% of the businesses established in a given year will be out of business within 5 years, low cost of start-up and simplicity of operation are a significant advantage of the sole proprietorship.

Disadvantages of Sole Proprietorships

Sole proprietorships have two main problems. First, all liability of the company, including all of the employment taxes if not paid, are the personal responsibility of the sole proprietor. Secondly, expansion of the business with additional equity holders is difficult because it requires at a minimum a change of form from a sole proprietorship to a partnership or a conversion to a corporation or a Limited Liability Company. The other disadvantage is that a sole proprietorship will need to do the necessary things to establish the business which are not much different nor less expensive than a Single Member Limited Liability Company. 

Sole proprietors paying the full burden of Social Security and Medicare taxes on sll nrt income rather than just the "salary" portion. For 2010, the first $106,800 of self- employment income is taxed at 12.4 percent for Social Security and 2.9 percent for Medicare for a combined 15.3% tax. This tax is not deductible, so you are effectively paying tax on tax. Any amount over $106,800 continues to be taxed at 2.9 percent for Medicare only.

The Sole Proprietorship form of business is appropriate for many if not most businesses.

1. Personal Liability. There is a natural concern about the "unlimited liability" aspect of the Sole Proprietorship. In some circumstances, liability is not an issue because it is adequately covered by insurance and malpractice insurance. If the appropriate coverage is not available, limiting the risks by having a Single Member LLC or corporation would be most advisable.

2. Personal Liability for Debts. The sole proprietor has personal liability for all the debts and obligations of the business. This puts personal assets at risk if something goes wrong with the business, and no insurance coverage is available.

3. Personal Liability for Employment Taxes. The sole proprietor is personally liable for both the employee's portion (trust fund) and employer's portion of employment taxes. A corporation or Limited Liability Company would also be liable for both the employer and employee. Nevertheless, if a corporation or Limited Liability Company were to go out of business owing employment taxes, the responsible parties (members, shareholders, officers) would be liable only for the trust fund portion and not the employer's portion.

4. Limited Existence. When the sole proprietor dies, the sole proprietorship goes out of business and may be difficult to continue as a viable entity.

5. Sale/Transfer of All or Part of the Business. The sole proprietor can transfer the business only by the sale of business assets. This means it is more difficult to have someone buy into the business, and there are potential tax consequences of converting a sole proprietorship to a corporation or a Limited Liability Company rather than starting out with a durable form of business entity.

6. Taxation. Taxation of the sole proprietorship is reported on Schedule C of the U.S. 1040.

7. Cost of Operation. The cost of operating a sole proprietorship versus a Single Member Limited Liability Company is about the same for accounting and business operating purposes. There is no advantage to the sole proprietorship.

8. Advantages. The sole proprietorship is easy to form and easy to end. Nevertheless, taking in potential equity holders/partners, or getting investors is legally difficult. Unless the business is a professional practice or other small service business, it is probably advisable to have a durable entity such as a Limited Liability Company or corporation.

 
 

 

 
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