Pros and cons of sole proprietorship

A sole proprietorship can be a business with only one member that has not been incorporated by state filing. There are pros and cons to sole proprietorships. However, there is no distinction between owner and business and no liability protection. While sole proprietorships can reduce startup costs, they won’t limit your personal liability.

No matter how your business structure is set up, it is important to keep your personal and business finances separate. Combining funds can lead to huge tax, accounting, and liability headaches. Chase ranked first in our review of the best business bank options. A $300 bonus is available to new customers.

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Sole Proprietorship: Pros and cons

 

The advantages of a sole proprietorship Cons of Sole Proprietorship
Simple Setup and Affordable Unlimitable Liability
No corporate business taxes There is no ongoing business life
There are no annual reports/filings It is difficult to raise money
No restrictions on the use of formal business structures Inability to take on business debt
Simple Recordkeeping It can be regarded as unprofessional

 

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5 Advantages of a Sole Proprietorship

The easiest type of business is a sole proprietorship. This type of business does not require any formal setup, annual administration, dedicated taxes or formal record keeping. A sole proprietorship allows you to simply sell goods and services. All bills and debts are your responsibility. All income from business is pass-through, and can be filed on your personal tax returns.

These are the five benefits of being a sole proprietorship:

1. 1. Easy setup and low cost

A sole proprietorship does not require you to file any paperwork or complete formal business structures. The only thing you need to do is start your business. You don’t even have to pay any filing fees or incorporation fees. You may need a permit, special license, surety bonds or business insurance policy depending on your industry. However, you don’t have to file any filings with the state.

This ease of setup and low cost of administration/management makes sole proprietorships great for cottage industries and seasonal businesses. It can be very beneficial to start a new venture, especially one that does not have significant liability.

Sole proprietorships are so easy to establish that they don’t require owners to take the necessary steps to incorporate. This would give them liability protection and other benefits. These steps are not required for sole proprietorships, and they also forfeit the liability protection that comes with formal business structures.

You can protect your liability by incorporating as an LLC using a service such as Rocket Lawyer. You can legally seperate yourself from your business by having them assist you with federal and state filings.

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2. 2.

You don’t have to pay 21% corporate taxes on your business profits as a sole proprietor. You simply keep filing personal tax returns, and any income you receive from your business is claimed as pass-through taxes. All income is subject to your normal income tax rate. Solo proprietors often are exempted from the state franchise and excises taxes.

These exemptions make taxes for sole proprietorships much simpler and less expensive than those of C-corps. Revenue is taxed at company level, and then again when dividends are paid to shareholders. The current dividend tax rate is between 15-20% and 41%, meaning you can pay up to 41% on your taxable profits. This does not include income tax that you pay on your salary.

Pass-through tax benefits are not only available to sole proprietorships. Both LLCs and Scorps can be considered pass-through entities. They avoid double taxation as well as the corporate tax rate. However, LLCs can be subject to franchise or excises tax depending on their operations. This means that taxes may still be higher than sole proprietorships depending on the level of profit.

As a sole proprietor, you might be subject to the following taxes:

  • Normal income tax – As a sole proprietor, there is no salary. All profits are instead filed on your personal tax return, and taxed at the ordinary income tax rate.
  • Self-employment taxes – If you own a business, you will have to pay self employment tax on all income earned by that business. This is the employer-portion FICAtax. This means that you will pay 7.65% additional taxes, or 15.3-16.2% FICA taxes.
  • Sales Tax – Depending on the nature of your business, you might need to collect and pay sales taxes if you sell goods. The amount varies from one state to another, but is usually between 6-9%.

3. There are no annual reports or filings

Solo proprietorships don’t need to file annual reports with the state. You don’t even have to file any other tax returns. This is in contrast with LLCs or S-corporations which generally have to file an annual report after they are formed. This report usually requires the updating of managers or members’ lists.

You would need to file many additional filings if you decide to use an LLC or LLP, Scorp, C-corp, or other entity instead of a sole proprietorship.

  • When you officially establish a company.
  • Annual filing- Charged in most states to keep you company current
  • You must notify the state if you are changing managers or directors.
  • List members –Many types companies must inform the state when their members change
  • An annual audit – Some companies must submit an audit every year
  • Company tax returns Certain types of companies must prepare corporate tax returns, and pay separate taxes for business profits

It is beneficial that sole proprietorships do not have to file an annual return. This saves time and headaches. However, most states charge a fee of $50-$200 for annual filings. Solo proprietors need only file their annual tax returns.

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4. 4.

Others, which are more structured, have certain restrictions on their operations and must meet additional requirements. These requirements do not apply to sole proprietorships. As a sole proprietor, you are free to make any business decision you like, provided it is legal. There is no approval or formal review.

You can skip certain requirements for other business types if you are sole proprietor:

  • Annual meetings –Companies like LLCs must hold an annual meeting to review the lists of members and managers
  • Board Meetings – Some companies must have certain business decisions officially approved by directors
  • Recorded Minutes –Formal minutes must be kept for these meetings of LLCs and corporations
  • Shareholder votes Any formal actions by the company, such as appointing new managers or admitting members, must be voted upon
  • Formal Reviews – Managers need to be formally re-appointed and certain actions must be reviewed.

5. Simple Record Keeping

An LLC or other formal-structured business requires you to separate your personal and business finances. You run the risk of being open to unlimited liability. This is known as “piercing corporate veil.”

Sole proprietors are subject to unlimited liability so many sole proprietors don’t separate their finances. Sole proprietors deposit their business income directly into personal accounts and pay all bills and debts themselves. They treat the business as an extension to their personal finances. This could make it easier to run a sole proprietorship than an LLC.

Although it is simpler to keep business and personal finances separate, it is often not a good idea. Separate records allow you to monitor cash flow and help you manage your business better. First, open a checking account for your business.

Separating finances in a sole proprietorship won’t protect your assets, but it can assist with bookkeeping, as the business grows. If you choose to change to an LLC, or any other type of business structure, it will make things easier. Chase was voted the best business account by us after we reviewed them all. Bonuses are available to new customers.

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5 Con’s of a Sole Proprietorship

Consider the pros and cons of sole proprietorship. One of the biggest disadvantages to sole proprietorship is that it allows for unlimited liability. The business owner can be held responsible for all obligations. If you are looking to grow your business, it is possible that W2 employees won’t be available (only 1099 contract employees).

The following are major disadvantages to sole proprietorships:

1. 1. Unlimited Liability

You don’t have the limited liability protections that an LLP, LLC or S-corporation offers if you are a sole proprietor. If someone is hurt by your business, a product you sell, or a mistake that you make, then you are personally responsible for any business expenses or debts. This means there is no legal distinction between you and your company.

You’ll be responsible for some liabilities in a sole proprietorship.

  • Your business’s expenses
  • Business-related debts
  • Product-related Liability
  • Property-related injuries
  • Insufficient or inappropriate service can result in civil damages

A sole proprietorship has unlimited personal liability. Customers, vendors, and lenders can seek your personal assets to pay any business obligations. This is in contrast with LLCs, Scorps and C-corps which provide a shield of liability between the business and its owners.

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The personal assets of the company owners are protected in an LLC or Ccorp. They cannot be taken by customers, lenders, or vendors to meet the company’s obligations unless the business owners do anything that would allow the corporate veil be lifted or if the owner signed a personal guarantee. A sole proprietorship may not be the right choice if you are looking to legally protect yourself.

Rocket Lawyer can help you form a single-member LLC. This will protect you from any liabilities that may arise from your company. You can visit them right away and receive legal documents in no time.

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Josh Zimmelman Westwood Tax and Consulting An LLC is a limited-liability company that protects your personal assets from creditors and lawsuits. Others entities, such as sole proprietorships and general partnerships, are unlimited liability companies. These businesses have the same owner and company. Therefore, you are liable for all debts of the business, even if the partner takes them on.”

– Josh Zimmelman, President, Westwood Tax & Consulting

2. 2.

Your business will survive if you set it up as an LLC or C-corp. Your business can continue to exist as long as your business files are current and you have proper licensing. However, if you are a sole proprietor and you have to go bankrupt, it is the end of your business.

There is no way to ensure continuity in a sole proprietorship. A family member or employee may be able to continue working in your business but they would be starting a brand new company. They wouldn’t be sustaining your operations. This makes it difficult to plan for the long-term and make succession plans for your eventual exit.

Sole proprietorships cannot hire full-time employees or W2 employees. Although you can hire 1099 independent contractors to work for you, it is not possible to manage payroll or retain employees over the long-term. You will need to incorporate an S-corporation or C-corp if you plan to hire employees in future.

3. It is difficult to raise capital

If you need to raise capital from outside investors, structuring your business as a sole proprietorship may not be a good idea. Because there is no business to sell, it is almost impossible to raise capital unless you have tangible assets and intellectual property that investors could buy into.

Sole proprietorships do not have equity shares and are not licensed businesses. There is no formal process for reviewing business decisions and approvals. Shareholders in sole proprietorships have virtually no rights. These concerns are why investors don’t usually invest in sole proprietorships.

Even an LLC can make it difficult to raise capital. However, you can elect an S-corp, which makes it much easier. A C-corporation is the best option if you need to raise capital, particularly from angel investors or venture capital firms.

4. You can’t take on business debt

A sole proprietorship is not a company that has been established. Therefore, it is not possible to obtain a loan for a business. All debt, even those you borrow to grow your business or run it, is considered personal debt. Lenders may require that all loans are personally guaranteed by the sole proprietor. This means they have the right to seize your personal assets in the event of default.

Because a sole proprietorship does not constitute a separate business entity, you own the business. You are personally guaranteeing the repayment of any business loans to sole proprietorships.

This may not be the case for other business structures. Even if you are an LLC, you will likely need to personally guarantee any type or loan you get, including an SBA Loan. When you take on business debt, make sure that you understand all of your personal responsibilities.

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5. 5. Perceived lack of professionalism

Customers and business partners often think sole proprietors lack professionalism. This may not be an issue for people who want to start a small business from home or make extra money. It is worth taking into consideration the pros and cons associated with a sole proprietorship when you are deciding on the type of business structure that you would like to use.

C-corporations, which are at the opposite end of the spectrum of sole proprietorships and partnerships, are commonly used by large companies around the globe. They are considered the most professional and well-respected. These entities are known for having the most rigid organizational structure and oversight regulations. However, they offer the best opportunity to raise outside capital and provide the highest liability protection.

Solo proprietorships on the other side do not have any form of oversight or management. A sole proprietorship simply means that someone is selling products or working for themselves. Sole proprietors often receive income from their business. Many bills are paid out of their personal accounts.

You can avoid some of this unprofessionalism by opening a small business checking bank in your business’s name. Many providers allow you to use an “doing business under” (DBA) alias. This will depend on the institution. You can find more information in our article on the Best Checking Accounts.

Sole Proprietorship Examples

The pros and cons of sole proprietorships make them ideal for small-scale entrepreneurs just starting out in low cost, low-liability ventures. This is also a better option for small-business owners with no substantial assets, which a creditor could pursue if the business fails.

These are some examples of sole proprietorships that are worth mentioning:

Amazon Businesses

Amazon businesses are often started by people who white label products. This can be done easily as a sole proprietor. You can find more information in our article How to Sell on Amazon.

Etsy Shops

To avoid the expense of setting up and managing a formal business entity, many sellers using Etsy are sole proprietors. You can find more information in our How to Sell on Etsy article.

Other Personal Business

Solo proprietorships can be used to run a variety of other businesses. Sole proprietorships can also be suited to independent service providers such as massage therapists or consultants via platforms like Upwork.

A sole proprietorship can work well for even a small snow-shoving or lawn-mowing business. In these instances, it is important to change to a business that offers liability protection prior to purchasing trucks and other equipment. For example, moving to an LLC or Scorp would protect you against personal liability in the event of injury.

If their business is only a small, part-time venture or a weekend business, some small business owners prefer to be sole proprietors. This allows them to avoid having to register or manage an LLC. However, those who grow eventually opt for a more formal structure which provides greater liability protection.

Alternatives to Sole Proprietorship

There are many business structures that can be used in place of a sole proprietorship.

Limited Liability Company

LLCs make it easy to create and manage a company. You can create them online in most states in as little as 5-10 minutes for $150-$200. Although LLCs offer limited liability protection for company owners, they require annual filings, up-to-date member lists, tax filings with K-1s issued members, and more formal administration.

Limited Liability Partnership

Limited liability partnerships are not available in all states. They can only be used to practice a licensed profession. They are tax-exempt entities and tax liability is passed to their owners based upon the ownership stake.

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Although LLPs function in the same way as LLCs, they can only be used within certain industries.

S-Corporations

S-corps, closely held corporations, are generally considered pass-throughs and receive special tax treatment in some areas. S-corps owners can pay their own salary, but the IRS doesn’t recognize LLC owners being entitled to a salary. However, they may deduct this expense from the corporate profit.

You can find more information in our article C-corps.

C-Corporations

C-corps are the most stable and expensive of all the business structures. C-corps are subjected to double taxation. Corporate profits are taxed at 21%. These profits are then subject to double taxation once they are distributed as dividends to owners of the company, at the individual income tax rate.

You can find more information in our article Ccorps and S-corps .

Is a Sole Proprietorship Right for

The pros and cons of sole proprietorships are beneficial for new business owners who are just starting out. They should not be entering a risky field or needing a lot of capital. They shouldn’t have to borrow money or be at risk of injury. Ideal would be a cottage industry.

Solo proprietorships work best for those business owners who do not have significant assets that could be taken over by creditors, vendors, or customers as a result of debts or liabilities incurred from the operation. This type of business is ideal for entrepreneurs who are just starting their business and plan to move to a formal structure later.

Frequently Asked Questions (FAQs

1. What are the advantages of an LLC over a sole proprietorship?

An LLC is a better option than a sole proprietorship because it limits your liability as business owner. The sole proprietor of a business is responsible for all its debts and obligations. An LLC allows business assets to be segregated from personal financial accounts. You are personally responsible for any business obligations only if you give a personal guarantee or do anything that would allow “piercing” the corporate veil.

2. 2.Why is it good to be a sole proprietor?

There are pros and cons to sole proprietorships. They can be very beneficial for small businesses or new ones. Unfortunately, many businesses fail. So it’s a good idea to start as a sole proprietorship until you know if your business will succeed. This is especially true for businesses that don’t require large amounts of outside investment or involve a lot of liability.

3. Are You Required to Register as a Sole Proprietor

You don’t need to register as sole proprietor. Depending on the industry you work in, you may need to register for specific licenses.

4. What is the best way to pay taxes as sole proprietor?

You can structure your business as sole proprietorship and continue to pay your personal taxes. You can claim any income you earn from business operations and pay self-employment taxes. Depending on the location of your business, you may need to collect and pay local and state sales tax for any goods that are sold.

Bottom Line

The sole proprietorship is an informal, great structure for small business owners. It is important to weigh the pros and cons when choosing a business structure. These businesses don’t offer liability protection or make it difficult for their owners to raise funds, but they are easy to set up and manage.