What Constitutes a Sole Proprietorship?
Sole proprietorships are among the most common business structures in the United States. The business is unincorporated and ran by one person who is not required to register the business with their state. Owners report all profits on their own personal income taxes (the business is not taxed separately) which means the owner has sole responsibility for the entity’s liabilities, losses, and debts.
For those who plan to run a company on their own, a sole proprietorship provides an effective way to set up a business. Many businesses may later expand to a more traditional structure as they grow, but the sole proprietorship provides a solid first step in business ownership.
Sole proprietors have complete control over their business. They have no partners (unless the owners are a married couple) and do not operate as a corporation. A sole proprietorship provides no separation between the business and owner. The owner assumes all tax obligations and legal liabilities. Many sole proprietors conduct business under their own names.
What Are the Advantages of a Sole Proprietorship?
A sole proprietorship provides a simple and cost-effective way to set up a new business. Many people who work for themselves, such as freelancers, operate as a sole proprietor, according to the Small Business Administration (SBA). Formalizing the structure is simply a matter of the owner filing to get the proper license and permit from the state.
By becoming a sole proprietor, an owner can operate the business under a different name from their own (known as a DBA name, for “doing business as”). Another benefit of sole proprietorships is that the sole owner of the business has complete control over all business decisions. Additionally, tax preparation is typically less time consuming as owners report all profits on their personal tax return.
What Are the Disadvantages of a Sole Proprietorship?
Unlike in other business structures, in a sole proprietorship, the owner and entity are considered one and the same. While this may be beneficial in some respects, it also means that the sole proprietor does not have legal protection and can be held personally liable for the business. Without this legal separation, personal assets of the owner’s are not protected; that means vehicles, houses, and other collateral can be seized because of company debts or if the company is the target of legal actions.
Banks often hesitate to lend to a sole proprietorship, making it difficult to raise capital to invest in the business. A less concrete–but no less important–disadvantage is the stress experienced by some sole proprietors. The SBA notes: “The flipside of complete control is the burden and pressure it can impose. You alone are ultimately responsible for the successes and failures of your business.”
What Are Examples of Sole Proprietorships?
The IRS provides a list of business areas (nonfarm) where sole proprietorships operate. Each proprietorship is owned either by a single person or a married couple. The business areas, with the number of sole proprietorship returns filed include:
- Professional, scientific, and technical services (Avg. 3.6 million): Includes legal services, accountants, architects and engineers, and computer systems design.
- Transportation and warehousing (Avg. 2.5 million): Includes more than 1.1 million sole proprietorships registered as a taxi, limousine, and ridesharing services; truck drivers, couriers, and messengers; and support services such as towing companies.
- Construction (Avg. 2.9 million): The bulk of these businesses (2.2 million) are specialty trade contractors.
- Retail trade (Avg. 2.4 million): Online retailers make up more than 880,000 of these businesses. Others include mail-order businesses, health and personal care stores, and clothing and accessory stores.
- Health care and social assistance (Avg. 2 million): More than half (1.2 million) are ambulatory health care services. Others include physicians, mental health practitioners, outpatient care centers, home health care services, dentists, and chiropractors.
- Arts, entertainment, and recreation (Avg. 1.7 million): Includes businesses in the performing arts, spectator sports, and legal gambling.
Tens of thousands of sole proprietors also run auto repair and body shops, laundry services and small grocery stores, according to the IRS.
The Importance of Business Structures
Choosing a business structure is a key decision for a business owner. The choice defines the legal structure of a business and impacts day-to-day operations, tax liability, and the type of reports owners must file. Owners and future business owners are encouraged to thoroughly research the rules that govern each business structure.