A sole proprietorship is the most basic business entity type. By definition, a sole proprietorship consists of only one owner who does business without any formal incorporation. If you add a second owner, then the business automatically becomes a general partnership. A sole proprietorship is legally indistinguishable from the individual.
Below is a discussion of the characteristics of a sole proprietorship based on the factors to consider when choosing a business entity.
Personal Liability (Unlimited Liability)
Because a sole proprietorship is indistinguishable from the individual owner, the business does not provide any type of shield to creditors of the business. The business’ creditors are the individual’s creditors. This is the most significant risk of operating your business as a sole proprietorship. But it is important to note that the limited liability that comes from formation of an LLC or incorporation of a corporation does not shield the individual’s assets from liability from the personal negligence of a business owner. So if you operate a business that is based entirely on your own personal services, limited liability may not be a reason to move to a more formal entity (although there may be other reasons to do so anyway).
Tax Treatment of Sole Proprietorship
In a sole proprietorship, there is no entity level tax. The business reports its profits and losses on the individual owner’s tax return using Schedule C and will be subject to self employment taxes. Generally, sole proprietorships must report estimated taxes quarterly. Although taxation of a sole proprietorship is simple, there are often tax benefits to moving the business to an LLC or corporation.
Sources of Funding
Because a sole proprietorship is indistinguishable from the individual owner, the only sources of funding that are available to a sole proprietorship are the sources generally available to individuals. So while you may be able to get a loan for the business, you can’t raise any equity funding by giving up an ownership interest in your business.
In California, you are not required to file any paperwork with the State or elsewhere to create a sole proprietorship. The exception is when you do business under a trade name (i.e. a name that does not include your name), which requires filing a fictitious business name statement in the county where your principal place of business is located. Additionally, there are virtually no formalities associated with sole proprietorships and control of the organization is solely vested in the individual owner.
DISCLAIMER: The information in this article is provided for informational purposes only and should not be construed or relied upon as legal advice. This article may constitute attorney advertising under applicable state laws.