Sole Proprietorship ... The vast majority of small businesses begin as sole proprietorships because this is the simplest type of business structure for an individual to establish. There are no documents you have to file, per se. Once you establish a sole proprietorship, you and your business are legally considered one and the same. This means: you own and operate 100% of your business, report all business income and losses directly on your own federal tax return, and are personally responsible for all business debts and obligations.
You can operate your sole proprietorship literally forever as long as you're the "sole" owner of the business.
Co-Sole Proprietors
There is one exception to the "sole" owner rule. You can share ownership of your business with your legal spouse and still maintain it as a sole proprietorship. If you do this, the IRS will consider you "co-sole proprietors." You can either split business profits and losses on separate returns, or put them on your joint Schedule C return.
This arrangement, sometimes referred to as a husband/wife sole proprietorship, allows your spouse to help with the business (without pay) without having to classify him or her as an employee (which would cause you to have to pay payroll taxes). Similarly, by not classifying your spouse as a partner or an independent contractor, he or she won't have to pay self-employment taxes, and your business won't have to file a partnership tax return.
Advantages of Sole Proprietorships
The advantages include:
Complete Control. You have 100% ownership of, control over and responsibility for your business.
Simplicity of Operation. Record keeping is streamlined and required legal documentation reduced.
Cost-effectiveness. Sole proprietorships are inexpensive to start-up and maintain.
No Double Taxation. Because the business is not treated as a separate taxable entity, all business income is reported on the owner's individual tax return and is therefore only taxed once. Finally, if you have a business loss, you may be able to use it to offset income that you receive from other sources.
Tax-free Savings. Available tax sheltered retirement programs, such as Keogh plans, can allow a sole proprietor to salt away a substantial amount of income free of current taxes. You can't really do any better by setting up a corporation.
Disadvantages Of Sole (And Co-) Proprietorships
These include:
Liability. The owner is personally liable for any obligations of the business. This means creditors and lawsuit claimants can sue your personally, going after not just your business assets, but your other personal property as well. Likewise, personal creditors can also go after your business assets.
Limited Ownership. A sole proprietorship by definition is limited to one person or a married couple. If the owner wants to admit another owner, the sole proprietorship would have to end and a new business arrangement, such as a partnership, would have to be created.
Higher Taxes. In some circumstances, other forms of business structures may offer substantial tax advantages, depending on the level of profitability of your business. As a sole proprietor, the income of your business is taxed to you in the year that the business receives it, whether or not you remove the money from the business. By contrast, as a shareholder in a corporation, you don't pay tax on money earned by the corporation until you receive payments as compensation for services or as dividends. The corporation pays its own taxes on overall business income.
Additionally, compared to a sole proprietorship, a corporation can offer certain tax advantages if you're able to leave a measure of income in the business as "retained earnings." For example, suppose you wanted to build up a reserve to buy new equipment or inventory. In either case, you might want to leave $50,000 of profits or assets in the business at the end of a year. If you operated as a sole proprietor, those "retained" profits would be taxed at your marginal tax rate. But if you incorporated, the rate would most likely be lower.
Medical Write-offs. As a sole proprietor, you can deduct only 40% of your family's health insurance premiums on Form 1040. If you form a corporation, however, and hire yourself as an employee, the corporation can pay for 100% of your family's health insurance premiums and uncovered medical expenses, and then take these amounts as a business deduction.
Steps to Form a Sole Proprietorship
So if you've decided you just have to have a sole proprietorship, all you have to do is take the following steps. Most are the same that are needed to form any kind of business:
1. Decide on a business and business name, address and phone number.
2. If you are doing business under a trade name rather than your own, publish then file your DBA or fictitious name certificate with the appropriate local or state public office.
3. If required by state and local laws, obtain a business license, which allows you to conduct business. You may also need a business sales tax license and relevant permit(s), so investigate this at the same time.
4. If you will have employees, obtain an Employer Identification Number (EIN) from the IRS.
That's it. As mentioned in the beginning, you and your business are now joined at the hip, legally one and the same. From now on you must report all business income and losses directly on your federal tax return, and assume responsibility for all business debts and obligations. You are the sole proprietor and can operate your business as such indefinitely. Just remember that if you want to bring in another owner or start paying your spouse, you will need to adjust the structure.
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