The sole proprietorship is the simplest and most commonly used structure for businesses. It is an unincorporated business owned and run by one individual with no distinction between the business and the owner. Every asset of the business is owned by the proprietor and all debts of the business are the proprietor’s personal debt. One of the advantages of being a sole proprietorship is that you do not file separate taxes for your business; you simply report all of your business income and losses on your personal income tax return.
Formation of a Sole Proprietorship
You do not have to take any formal action to form a sole proprietorship. As long as you are the only owner you are the sole proprietor. The status of being a sole proprietorship automatically arises from your business activities. In fact, if you are in business and do not have a business entity, then you are a sole proprietor.
Like all businesses, a sole proprietor needs to obtain the necessary licenses and permits. Regulations vary by industry, state and locality. At the Coover Law Firm, our attorneys can help you acquire all of the state, county and local permits, licenses and registrations you will need to run a business.
Registration of a business name for a sole proprietor is generally uncomplicated, unless it involves the selection of a name that is fictitious, or “assumed.” The business owner is required to register with the appropriate Maryland authorities, who will determine that the name submitted is not currently used by another business entity. Additionally, the business owner must complete and file a Trade name application with the State.
Taxation of a Sole Proprietor
One of the advantages of a sole proprietorship is its simplicity. You do not report business income on separate tax returns for your business; you simply report all of your business income and losses on your personal income tax return. It is always wise to seek help from experienced business accounting professionals when forming any type of business including a sole proprietorship.
Since income from a sole proprietorship is taxed as personal income, the tax amount depends on your personal income tax bracket. The more income the business generates, the more personal income you have, and the higher your rate of taxation will be. However, certain business entities are not only taxed separately, but also at potentially lower tax rates than personal income. It is possible to pay less tax by forming a business entity than running it as a sole proprietorship.
For example, consider if your business made $200,000 in profits last year. A corporation would be taxed about 15% on the first $50,000, and then 25% on the remaining $150,000. As personal income however, that same $200,000 most likely moves you into a tax bracket higher than 25%. In this example as well as many others, you would end up owing significantly more taxes as a sole proprietor than as a corporation. On the other hand, you must consider whether or not the expenses of entity formation and tax preparation outweigh the advantages of the easier tax preparation associated with a sole proprietorship.
Sole Proprietorship Advantages
- Easy and inexpensive to form: A sole proprietorship is the simplest and least expensive business structure to establish. Costs are minimal, with legal costs limited to obtaining the necessary license or permits, and securing a business name.
- Absolute control: Since you are the sole owner of the business, you have complete control over all decisions regarding the business.
- Family Oriented: The IRS has an exception that a spouse may work for the sole proprietor and not file taxes as a partnership.
- Simplified taxation: You and the business are not taxed separately, making tax filing requirements for a sole proprietorship the most simple to satisfy. The tax rates for a sole proprietor are also the lowest of the business structures.
Sole Proprietorship Disadvantages
- Unlimited personal liability: Because there is no legal separation between you and the business, you can be held personally liable for the debts and obligations of the business. This risk extends to any liabilities incurred as a result of employee actions.
- Capital can be tough to find: Sole proprietors often face challenges when trying to raise money. Because you can’t sell stock in the business, investors won’t often invest. Banks are also hesitant to lend to a sole proprietorship because of a perceived lack of credibility when it comes to repayment if the business fails.
- Absolute responsibility: The flipside of complete control is the burden and pressure it can impose. You alone are ultimately responsible for the successes and failures of your business.
Business entity structure chosen affects many aspects of the business, including taxation, liability, governance, management and control, transfer of ownership and more. Attorneys at the Coover Law Firm, LLC advise clients on their options and handle all aspects of business entity formation with the structure that meets their needs and goals.
For any business, commercial or corporate legal matter in Columbia, Maryland and surrounding areas, call the Coover Law Firm, LLC at 410-995-1100 or toll free at 866-425-9555, or contact the firm online to discuss scheduling an appointment with our attorneys.