What Is a Sole Proprietorship?

A sole proprietorship is a single owner of an unincorporated business who typically operates the business as an extension of themselves. Profits and losses of the business are reflected on the tax return of the owner.

One risk of a sole proprietorship is that liabilities of the business belong to the owner. For example, if someone sues the business and the company is unable to pay the damages, the owner's personal assets and property may be at risk.                                                                                  

Sole Proprietorships vs. Corporations

  • Sole proprietorships and partnerships cost less to establish and manage. Officers, meetings, and company shares are not required. Filing fees and annual fees, if any, are less than required of a corporation.
  • Corporations are formed by filing legal documents with the state. They must have meetings for the director and shareholders, record corporate minutes, and get board approval for major transactions. Sole proprietorships can operate without even a written agreement.
  • Sole proprietors and partners are not required to pay for unemployment insurance. In a corporation, a shareholder-employee must pay federal unemployment insurance taxes on his or her salary, up to $434 per employee. Sole proprietors are entitled to a credit if required to pay state unemployment tax.
  • Taxes are simpler for a sole proprietor. The owner earns or loses what the business does. The income passes through to the owner's tax return.

Disadvantages of Sole Proprietorships

  • The owner is liable for any business debts. Personal assets, such as bank accounts, cars, and homes, are at risk.
  • Business assets could be wiped out to pay the owner's debts. If the owner gets into a car accident and is sued personally, the business can be seized.
  • It's difficult to raise capital, since there is no way to assign shares of the business.

Limited Liability Company Facts

  • An LLC is a legal entity that can be used to run a business or hold assets. It is a hybrid between a sole proprietorship and a corporation.
  • LLCs have been available for about 25 years and are becoming the most popular way to structure a business.
  • Owners and officers, also called members, are protected from liabilities of the company, including for their own negligence.

Advantages and Disadvantages of LLCs

Unlike sole proprietorships, LLC owners' personal assets are protected from business debts. The paperwork required is less than a corporation, and they are more flexible for business owners, entrepreneurs and real estate investors.

Tax laws vary by state, which could be a concern if an LLC does business in several states. LLCs may require at least two partners in some states, and lawyers may charge more to set up an LLC than a corporation. LLC's also cannot go public.

Corporations Facts

  • A corporation is most often used to run a large company with shareholders and investors. It is owned by one or more stockholders and managed by a board of directors elected by the stockholders.
  • Directors appoint officers, who run the day-to-day business of the company.
  • The stockholders, directors, and officers are protected from the liabilities of the company.
  • In a C corporation, profits and losses do not flow through to the tax returns of the owners. The corporation files its own tax return and pays its own taxes.
  • The stockholders may choose S corporation status. They are taxed like a partnership, and profits and losses flow through to the federal tax returns of the owners. For that reason, it's sometimes chosen by sole proprietors.

Advantages of a Corporation

  • Shareholders in a corporation are generally not liable for corporate debts unless, for example, a shareholder personally guarantees a corporate debt. Also, a court may treat the acts of a corporation as the acts of the shareholders. This is sometimes referred to as "piercing the corporate veil."
  • Corporations offer self-employment tax savings. Only salaries, and not profits, are subject to self-employment taxes.
  • Corporations continue beyond the death of officers.
  • Corporations have more flexibility in raising capital, such as selling common stock and creating preferred stock.
  • Corporations can be sold to a third party. A sole proprietorship must transfer its assets and permits individually.                                                                           

If you need help setting up a sole proprietorship or LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.