This is the most common way of operating a small business and is the simplest to start up. There is no need to set up a separate legal entity, since the owner and operator of the business are the same person. In this sense, there are no specific legal requirements or costs involved in setting up the business.
Setting Up
A sole proprietorship is started simply by beginning to do business, either under the owner’s name or another name. If a different business name is used, it may be necessary to file a fictitious name certificate, and a business permit may be required in the state or locality in which the business is located.
Ownership and Control
The owner has complete control of the business. A sole proprietorship can have employees and the owner can delegate authority and decision-making, but the owner has final legal responsibility for the decisions made and the actions taken by the business.
Liability
In a sole proprietorship the owner is personally liable for business obligations and losses. Since there is no separate legal entity, there is no distinction between the owner and the business, and creditors could potentially have recourse against the owner’s personal assets to cover business debts.
Continuity and Transferability
A sole proprietorship continues in existence as long as the owner is alive and wants to keep operating the business. The sole proprietorship ceases to exist when the owner dies, and business assets pass to the owner’s personal estate. The owner can freely transfer the business to another person, by selling the business assets. A sole proprietorship could also be sold to another legal entity, such as a partnership or corporation. The sole proprietorship would then end, and the business assets would become part of the purchasing entity’s assets.
A sole proprietorship can take on new owners by becoming a partnership or corporation. In this case, the business could continue, but it would no longer be as a sole proprietorship.
Taxes on Earnings
The owner is entitled to all profits from the business, and also assumes all losses. There could be a profit-sharing plan with the employees of the sole proprietorship, but there is generally no legal obligation to do so, and this would be at the discretion of the owner.
Business profits and losses are reported on the owner’s individual income tax return each year and are taxed at individual income tax rates. The owner must pay self-employment tax on income from the sole proprietorship, and must withhold payroll taxes and pay the employer’s portion of payroll taxes for any employees of the business.