What is a Sole Proprietorship?
A sole proprietorship is one of the simplest and most common structures for entrepreneurs. It is an unincorporated business with only one owner, which is you. You do not have to register your business with your state. Also, there is no legal distinction between you and the business. You as the owner are entitled to all profits from the business. On the other side though, you are also liable for all debts and losses.
How is a Sole Proprietorship taxed?
The income from your business is reported on your individual tax return on Schedule C. Keeping track of your business’s income and expenses throughout the year is of the utmost importance when it comes to how much you will be paying in taxes. The net income from your business is subject to both income tax and self-employment tax. Income tax rates depend on level of income. The self-employment tax rate is 15.3% of your net business income. Self-employment tax is a tax consisting of Social Security and Medicare taxes.
What are the advantages and disadvantages?
Advantages:
- Very easy to form and the cost is minimal.
- You are the sole owner of the business so you are entitled to all of the profits.
- There is no separate tax return. The business income and expenses are reported on your individual income tax return on Schedule C.
- Record keeping is easy.
Disadvantages:
- Since there is no legal distinction between you and the business, you are responsible for all business debts and liabilities. Your personal assets are at risk.
- Taxes can be high. The net income from the business is subject to income tax at your tax rate as well as self-employment taxes which is 15.3%.
- It is hard to get financing if needed.
- There is no ongoing life of the business after the owner.
How can I protect my personal assets?
You can protect your personal assets by forming a single member LLC. This is typically done by filing Articles of Organization with your state. When a single member LLC is formed, it is considered a separate legal entity. This creates a barrier between the owner and the company known as “The Corporate Shield”. Your personal assets can no longer be seized to pay for company debts. For tax purposes, the IRS considers a single member LLC as a disregarded entity. This means it is still reported on your individual tax return.
Is this structure right for my business?
If you are just starting out, and you are the only owner, this structure would be a good start. It is easy to create and maintain. Keep in mind that your business structure can evolve as your business grows. Having a CPA by your side to help you along the way can help put your mind at ease.