The sole proprietorship is the simplest business you can start, and the ease with which you can set one up makes them the most common kind of business, too. You don't have to file any special papers or pay corporate income taxes. You don't even have to come up with a name for the enterprise if you don't want to. You just go into business. However, the advantages of starting a sole proprietorship must be weighed against the risks.
A sole proprietorship is a company wholly owned and controlled by one person. You make all the decisions, reap all the rewards--and take all the risks. The "sole" in sole proprietorship applies only to the ownership structure; you can hire as many employees as you like, but none can have an equity stake in the company.
Usually there are no formal requirements for starting a sole proprietorship, so getting one up and running is relatively easy and inexpensive. Governance is also a snap, because you answer to no one but yourself.
Perhaps the biggest advantages of a sole proprietorship come at tax time. For one, your earnings are not "double-taxed." If you were to make your one-person business a corporation, you must pay yourself a salary. Your company's income would be subject to the corporate income tax, and then any salary paid to you would be subject to the personal income tax. So every dollar that flowed through to you would have been taxed twice. In a sole proprietorship, however, the government makes no distinction between you and your business. All income to the business is treated as your personal income and is taxed as such--only once.
Another big tax advantage of the sole proprietorship is the ability to use losses from your business to offset other income. Say you operated a lawn-care business as a sole proprietor at the same time you held a regular office job. If the lawn-care business suffered a $10,000 loss, you could subtract that directly from whatever you were paid by your employer in the other job. If your business had a particularly terrible year, you could theoretically use the losses to reduce your taxable income to zero and wipe out your entire tax bill for that year.
Unfortunately, since the law sees no difference between you and your company, your creditors won't see one, either. Unlike in a corporation or limited liability company (LLC), the business debts of a sole proprietorship become the personal debts of the owner. Creditors can go after your house, car or other assets to pay off your business debts.
Because of the way sole proprietor income is reported, you don't have to file separate tax returns for yourself and your business. Report all business income on Schedule C, an attachment to the Form 1040 individual return.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.