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What Is Sole Proprietorship?

The sole proprietorship is an unincorporated business that has only one owner. It is the least complicated and least regulated business organization model. The sole proprietorship is a simple pass-through entity; profits and losses pass through the business and are reported on the tax return of the owner/sole proprietor.

Just as the sole proprietorship does not pay taxes directly, it also does not shelter the owner/proprietor from potential creditors, obligations or judgments. In the eyes of the law, the sole proprietorship and its owner are one in the same. The owner is liable for any action that is brought against the sole proprietorship that is his or her business.

Although there may be no papers that need to be filed, in order for the business owner to declare his or her business a sole proprietorship, depending on the home state, there will be the same licenses, permits, sales tax numbers, etc., that are required of any business.

The simplicity of the sole proprietorship is also its major fault. Without the formality of other types of business organization, it is common for sole proprietors to commingle their business and personal bookkeeping. On one level, this commingling is invited, because losses in the business can sometimes be used to offset profits that come into the family from other sources. But this offsetting can still be used when completely separate books are kept, for the business and for the family, and that is the model that should be adopted by any sole proprietor.

In addition, there are a number of other limitations to a sole proprietorship, which should be considered before this form of business organization is implemented:

All assets belonging to the sole proprietor, and his or her immediate family, are liable, unless protected by a trust, or other shelter.

Commingling business and personal finances can make it difficult to measure business performance, and it may make it impossible to secure business credit or loans.

The business cannot survive the death of the sole proprietor. A death forces the creation of a new business.

Without a carefully structured succession plan, a sole proprietorship cannot pass to another family member without incurring imposed taxes, because the transfer will be categorized as the sale of a business.

Obviously, the lack of paperwork and low cost of setting up a sole proprietorship can be attractive to many potential business owners. But there are clearly drawbacks that should be weighed against the lure of simplicity.

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Information here does not constitute a legal advice. Please contact an attorney or accountant for specific expertise.

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