1. Sole Proprietorship Basics
2. Taxes and Sole Proprietorships
3. Filing as an S Corporation
4. Sole Proprietor's Assets and Incorporation

Can a corporation own a sole proprietorship? No, by its very nature, a sole proprietorship is a business owned and operated by a single person, so a corporation cannot own a sole proprietorship. However, if you own a sole proprietorship, you do have the option of converting your business to a corporation, which provides several benefits.

Sole Proprietorship Basics

If you want to open a new business, your simplest, most cost-effective option is to start a sole proprietorship. Unlike corporations and limited liability companies (LLCs), sole proprietorships are not distinct legal entities. Basically, this means that the owner of the business and the business itself are considered the same for legal purposes.

When you start a sole proprietorship, you can either run your business using your legal name or a fictitious name. Understand, however, that just because you are using a fictitious name, it doesn't mean your sole proprietorship is a separate legal entity.

Sole proprietorships are popular with small-business owners for several different reasons:

  • They are easy to establish.
  • They are simple to operate.
  • They are cost-effective.

To start a sole proprietorship, you only need to register your business name and acquire a business license. The biggest drawback of starting a sole proprietorship is that you will be held liable for the debts of your business. If your sole proprietorship runs into financial trouble and can't pay its debts, your creditors can file a lawsuit against you. If you lose the case, your personal assets could be seized to cover your debts.

Taxes and Sole Proprietorships

Simple taxation is one of the main reasons that people choose to form sole proprietorships. Because the business and its owner are one and the same from a legal standpoint, any income earned by the business is considered the owner's personal income will be taxed on their individual return.

To report the profits and losses of your sole proprietorship, you will need to include a Schedule C form along with your 1040 return. The final amount that you list on your Schedule C form will be applied to your 1040. Sole proprietors must also submit a Schedule SE form for self-employment taxes. Unemployment taxes are not required for the sole proprietor, but you will need to pay unemployment taxes for any employees that you have hired.

Filing as an S Corporation

Some sole proprietors decide to later incorporate their business as an S corporation to take advantage of more beneficial tax rules. Deciding to incorporate your sole proprietorship will affect several issues, including your personal liability and your tax burden. It is possible to establish a single-person S corporation, but you will not be able to take advantage of S corporation tax status until you've completed the incorporation process.

S corporations are legally separate entities from their owners, called shareholders. If you are planning to incorporate your sole proprietorship, you should be aware that S corporations and traditional C corporations are different from one another in many regards. For instance, S corporations benefit from pass-through taxation, which means that corporate income gets reported and taxed on shareholders' personal returns.

Sole proprietorships that plan to incorporate as an S corporation must prepare themselves for the time-consuming and potentially expensive incorporation process. Forming an S corporation requires several steps, including:

  • Filing formation documents.
  • Making a special IRS tax election.
  • Obtaining a tax identification number.
  • Reporting business income, distributions made to shareholders, and payments made to employees.

In addition to the lengthy formation process, establishing an S corporation also means you'll have to observe corporate formalities such as holding annual shareholder meetings and filing annual reports.

Sole Proprietor's Assets and Incorporation

If you decide to transition your sole proprietorship into a corporation, you must consider how incorporation will impact your business assets. With a sole proprietorship, you can use your business assets however you wish, as they are legally considered to be your personal assets. For example, if your sole proprietorship has a delivery truck, you could use the truck for your personal transportation.

When incorporating your sole proprietorship, you will need to decide which of your assets you will transfer to the new business. Once you transfer an asset to your new corporation, personal use of the asset is no longer allowed.

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