A sole proprietorship is owned and operated by one individual. It is the least complicated and usually the least expensive way to set up and run a business. Apart from its owner the sole proprietorship has no legal existence.
The advantage of a sole proprietorship is its simplicity and the relative freedom from government regulations and special taxation. The owner controls the business, makes decisions without having to consult co-owners or partners, and is entitled to all profits (or losses).
The business income is taxed to the owner via a Schedule C attached to the individual’s Form 1040. Income taxes are not withheld on business income, though quarterly estimated taxes may be required.
A sole proprietor can establish a retirement plan. Good options include an IRA, a SEP, or a Keogh. Each type of plan has its own restrictions and requirements so the business owner should review all options in order to select the most appropriate plan. Payroll taxes apply to any employees of the business. The sole proprietor pays self-employment tax rather than social security tax (and gets a tax deduction for 50% of the tax paid). No social security tax need be paid on the owner’s children under the age of 18 who work in the business.
A major disadvantage to the sole proprietorship form of operation is Unlimited Liability, not only for debts of the business, but for lawsuits brought against the business. Liability extends to the proprietor’s personal as well as business assets.
The ability to raise capital for the business is limited to the amount the individual can secure personally. Since under-capitalization is seen as a major cause of business failure, this factor can be significant.
Continuity of a sole proprietorship is limited. Since the individual IS the business, the enterprise may be crippled or terminated if the owner becomes ill or dies. This factor however has more to do with the typical operational structure than regulation. A sole proprietorship, by virtue of its typically smaller size, is less likely to have a hierarchal staffing structure capable of carrying on business in the owner’s absence than would a larger firm. By the same token, any form of business without sufficient staffing in place to carry on business would suffer a similar fate.
The deductibility of fringe benefits is very limited in a sole proprietorship. In fact, this area comes under close scrutiny by the IRS because of concern that personal expenditures might be deducted as business expense.