Many businesses start out as sole proprietorships, and there’s a good reason to do so: A sole proprietorship is very simple and inexpensive to process.
“There is no cost to organize, and you don’t have to renew your business entity yearly with the state,” said Matt Jensen, a certified public accountant at Cook Martin Poulson. There are no requirements for annual owner meetings or filings with states, and in general, there is less administrative work, he said.
Sole proprietorships do not need to be renewed annually, they require less paperwork and they don’t cost much to process.
What are the disadvantages of a sole proprietorship?
Although a sole proprietorship is one of the simpler business entities, it puts a lot of responsibility on business owners. It offers zero legal protection of your personal assets, and there can be only one owner.
“If a business owner was sued, the owners could literally lose their personal car and personal home because of a business liability,” Jensen told Business News Daily.
Sole proprietorship also poses some security risks. “Another con is that when a business identification number is needed, the owner has to give out their Social Security number, greatly increasing the chance of identity fraud,” Jensen said.
Another drawback is that sole proprietors are not eligible for certain business tax breaks and small business loans. They could, however, be eligible for certain tax deductions intended for self-employed individuals.
Sole proprietorships provide no legal protection for business owners’ personal assets and aren’t eligible for certain business tax breaks or small business loans.
What are the tax implications of a sole proprietorship?
When filing your taxes as a sole proprietorship, you report your business’s income and losses on your personal tax returns. You’re also required to submit a Schedule C, “Profit or Loss from the Business,” as part of your IRS 1040 filing. This form is used to document the income and expenses for your business.
“A sole proprietorship doesn’t have to file a separate [business] tax return,” Jensen said. “A business schedule is attached to the owner’s personal tax return.”
Income earned by sole proprietorships is treated like personal income, which is why it’s reported on your personal tax return.
You may instead be able to submit Schedule C-EZ, which documents your net profit from the business. Because the sole proprietor is considered both the employer and the employee, he or she is responsible for paying both the employer and employee portions of Social Security and Medicare taxes through Form SE, “Self-Employment Tax.” The employer portion of the tax can be claimed as a tax deduction when filing your tax return, however.