Sole Proprietorship

What Is a Sole Proprietorship?

A sole proprietorship is a type of business organization where the business is owned, controlled, and operated by a single person, with no separate legal entity from the business. It is also called sole tradership, and the company owner is called the proprietor.

It is the most common form of business in the U.S. There is no share of profits and losses as a single person runs and owns the industry, with unlimited liability of the proprietor towards the company. 

There are no partners in this type of business. It also has fewer legal formalities for formation or dissolution. Usually, sole proprietorship businesses are smaller in size and are, therefore, easier to control. 

The sole proprietor is the recipient of all the risks attached to the business as he/she is the only business owner. Therefore, the proprietor manages all the rights and responsibilities and controls the business and the respective strategies. 

The dissolution of the business happens with the death, bankruptcy, imprisonment, or physical ailment of the owner, as it directly affects the operations and controls of the company. In some cases, the legal heir or the successor can run the business on behalf of the owner. 

The owner ultimately decides the formation and closure of the business as the proprietor holds the sole rights of decisions. 

In some cases, some legal formalities like licenses are required. But, usually, the owners operate their business under their names rather than having a trading name for the company. 

One more attractive point for this type of organization is confidentiality, as only one person is involved. The information remains secure with the owner, reducing the misuse of accounting information as the information remains preserved. 

Some examples of sole proprietorships are small businesses like grocery stores, clothing stores, freelance writers, IT consultants, bookkeepers, freelance workers, artists, bakers, chefs, tutors, etc. 

Basic features of Sole Proprietorship

This form of organization has become popular in a few years and has gained a lot of interest from young entrepreneurs. The basic features which govern this type of organization to thrive in the competitive environment are as follows:

1. Formation and Closure: Easy formation and closure with fewer legal requirements and paperwork. 
2. Share of Profits: The owner is the sole recipient of the profits earned by the company from its operations.
3. Recipient of the risk: The owner bears all the risks involved in the business decisions and actions. 
4. Unlimited Liability: The sole proprietor has an unlimited liability which states that the owner is liable for all the debts and liabilities of the business, and personal belongings may also be used to repay the debts or meet obligations.
5. No separate legal entity: The business and the owner are not considered separate legal entities but single. 
6. Ownership and control: A single person owns, runs, and controls the business and takes part in decision-making for the company. No other person is needed to interfere in the decision-making of the business. 
7. Business continuity or closure of business: This type of business has an uncertain business continuity as if anything happens to the owner, the company gets directly affected, like death, bankruptcy, or imprisonment. These circumstances may lead to the dissolution or closure of the business. 

Advantages and Disadvantages Of Sole Proprietorship

Every type of business organization has its benefits or plus points, making them more convenient and better than other business organizations, for example, partnerships and companies.

Advantages

The following are some of the primary advantages of a sole proprietorship.

1. Quick decision-making: The decision-making is quicker as the owner does not need to ask, consult, or discuss with anyone else before making decisions as he holds the power to control the business and the right to make business choices. 
2. Confidentiality of information: The information remains private and secured, with the owner maintaining the confidentiality of the data. There are no legal requirements for sharing or disclosing accounting information to the general public.
3. No share of profits: As a single owner, there is no share of profits. Hence the revenue is enjoyed alone by the owner of the business. Profit is considered the reward for risk-taking; higher risks may generate higher potential profits and growth in the industry.
4. A feeling of satisfaction or accomplishment: The owner may feel accomplished and satisfied working alone with no interference and guidance from others. 
5. Easy formation and closure: The formation and closure of a business are relatively quick and easy procedures with no legal requirements. 
6. Low set-up costs: It is considered one of the significant benefits of setting up a sole proprietorship business as the costs involved in setting up the business and its operations are low compared to other forms of organizations, i.e., partnerships and companies. 
7. Minimal paperwork: There is significantly less or no legal paperwork required during the formation or closure of the business or while making any major decisions.

Disadvantages

The following are some of the limitations or disadvantages.

1. Unlimited Liability: The owner has an unlimited liability where the owner is liable for all the debt and obligations of the business as it is no separate legal entity. The owner's personal belongings may also be used to repay the debts or liabilities. 
2. Lack of expertise and managerial ability: The sole proprietor holds all the responsibilities and performs all the functions like sales, marketing, and finances. The owner may not have expertise in all the tasks and may have to compromise the other parts as he fails to employ people with expertise. 
3. Limited resources: The resources of the sole proprietor are limited to his savings and borrowings from outside. The business may not be able to raise additional capital as no sources restrain the business size from being small. 
4. Lack of business continuity: The business may get dissolved due to the direct impact of the sole owner's death, imprisonment, bankruptcy, or medical issues. 

Taxation Of Sole Proprietorship

The sole owners file the revenues and expenses in his/her personal or individual tax returns as the company has no separate legal entity from the owner. He/She pays income tax and self-employment tax on the gains. 

The tax forms to be filled include the standard tax form 1040, income tax form, self-employment tax form, Federal unemployment taxes (FUTA), and Medicare taxes. 

The income tax rate for the sole proprietorship is the same as the individual's income tax rate. For filing taxes, the proprietor must fill out the standard form 1040 and Schedule C, which determines the gains and losses in the company.

The amount of tax will be calculated on the combined income from Form 1040 and Schedule C. 

On Form 1040, the business is taxed through the sole owner's individual tax return, which also includes income from business operations. On Schedule C, the owner must present the calculated business profit for taxation. 

The taxation, however, will be held on the combined income from both sources. 

Keeping your business accounts and accounting separate from your accounts and accounting is one of the best ways to ensure you adhere to US sole proprietorship taxes.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Associate Company
• Buyback
• Diversification
• Industry Life Cycle
• Risk Transfer