The majority of businesses in the United States are sole proprietorships. The legalities of this business structure involve several pros and cons. If you work for yourself, and if you haven't formed any other business structure, you're probably already a sole proprietor.
You and Your Business Are the Same Entity
If your small business is a sole proprietorship, this means you haven't taken any steps to incorporate it and you have no partners. As far as the Internal Revenue Service (IRS) and state laws are concerned, you and your business are one and the same. You are your business, and your business is you.
Sole Proprietorships Require No Formation
Forming a corporation or a limited liability company requires that you submit paperwork to your state and go through a somewhat challenging legal process. Your sole proprietorship begins when you accept your first client or job. No official formation process is necessary, and you don't have to register your business with the government. Only one exception exists. If you want consumers to know your business by something other than your own name, in some jurisdictions you might need to register the name itself with your municipal government or with your state.
Tax Advantages and Disadvantages
Because a sole proprietorship doesn't exist as a separate legal entity, operating your business as one involves some tax implications. Your business isn't taxed separately from you, so the IRS only gets to take one bite from your earnings. You report all your business' income on your own personal tax return, using a Schedule C for Form 1040. The advantage is that you might lower your tax bill by deducting business losses from all your sources of income. The disadvantage is that you must pay your own Social Security and Medicare taxes, which may be more than 15 percent of your business income. If you instead form a corporation and take a paycheck, the business will pay about half of your Social Security and Medicare taxes.
No Protection Against Liability
A downside to your personal and business identity being the same is sole responsibility for any business failure. No legal business structure shields you from debts and liabilities. You're personally responsible for all business loans. If someone successfully sues your business, you're fully liable for any judgment.
A Business Lawyer Can Help
The law surrounding creation and operation of a sole proprietorship is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a business lawyer.