Sole proprietorship
A sole proprietorship is a straightforward business structure where an individual is the sole owner of an unincorporated business. This model is particularly prevalent in industries such as real estate, construction, and the arts. Legally and for tax purposes, the owner and the business are treated as one entity, meaning the proprietor retains all profits but also assumes complete responsibility for the business’s liabilities. Establishing a sole proprietorship is relatively easy, requiring minimal paperwork and initial investment—typically just the necessary licenses and permits.
While the tax process for sole proprietors is uncomplicated, as business income is reported as personal income, the sole proprietor must also pay self-employment taxes and manage quarterly estimated taxes. Importantly, unlike corporations or limited liability companies (LLCs), sole proprietorships do not offer personal liability protection; thus, personal assets may be at risk in the event of business debts or legal actions. Despite these potential drawbacks, sole proprietorships are increasingly popular, with millions of such businesses reported in the U.S. in recent years, especially in specific sectors. The option to transition to a different business structure remains available, though it involves certain procedural changes.
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Sole proprietorship
A sole proprietorship is a business structure that applies when an individual is the only owner of an unincorporated business. Industries in which sole proprietorship is common include real estate, construction, and the arts. The owner and the business are considered the same entity for legal and tax purposes, and as such, the proprietor may claim all profits from the business. However, the sole proprietor is likewise responsible for all liabilities incurred by the business and may be required to pay outstanding debts out of their personal assets.
Overview
When starting a business, an individual must first decide how the business will be structured for both legal and tax purposes. In the United States, several different business structures exist, each with its own set of advantages and disadvantages. Sole proprietorships are the simplest businesses to establish, as they require little paperwork and initial funding.
To form a sole proprietorship, an individual must simply obtain any licenses or permits required by local, state, or industry authorities—such as property use permits, permits to sell or serve alcohol, or licenses in trades such as carpentry—and begin to carry out business activities. If the sole proprietor wants to carry out business under a name different from their own, the individual must often obtain a license to do business under a fictitious name. Business regulations vary from state to state and district to district, so sole proprietors must research these regulations carefully and remain in compliance with all local, state, and federal laws. Taxes for sole proprietorships are relatively straightforward, as business income is taxed simply as part of the proprietor’s income. The sole proprietor is responsible for paying self-employment taxes (contributions to Social Security and Medicare) as well as estimated taxes on business income, usually on a quarterly basis. The Internal Revenue Service (IRS) automatically considers a single-owner business to be a sole proprietorship unless it is incorporated. Tax deductions for business expenses such as supplies and training help sole proprietors reduce their tax basis.
Sole proprietorships differ from businesses such as corporations and limited liability companies (LLCs) in that a sole proprietorship is considered legally and financially indistinguishable from its owner. This benefits the sole proprietor by simplifying the process of reporting income and paying taxes and allowing the proprietor to claim all of the business’s profits. However, choosing to form a sole proprietorship can be risky, as the proprietor has no protection from the business’s liabilities. If the business is unable to repay a debt, lenders may instead seek repayment from the proprietor. Similarly, if a customer or other individual sues the business, the proprietor may risk losing their own personal assets.
It is possible to convert from sole proprietorship to another ownership structure. The conversion process may entail getting a new employer identification number, as well as changing ownership of business assets to the new entity. Debts incurred under the sole proprietorship transfer as well, but the business owner must negotiate terms with the lender involved. Documents specific to the new structure, such as articles of organization and operating agreement for an LLC, must also be drawn up.
Despite the risks, sole proprietorships have become increasingly popular in the United States. According to a 2024 report by the US Census Bureau on nonemployer businesses (businesses that do not employ workers other than the owner or owners), in 2021 there were more than 24.7 million sole proprietorships in the country. Sole proprietorships constituted over 90 percent of nonemployer companies in the construction industry and more than 43 percent of nonemployer real estate companies.
Bibliography
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