A sole proprietorship is a type of business that is managed by one individual. There is no distinction between the business and the owner. The business owner must report all of the income from the business and is personally responsible for all of the debt of the business.
Because sole proprietorship provides no liability protection, it is rarely used. Single member limited liability companies offer the same tax flexibility as sole proprietorships without the unlimited exposure and are usually the preferred form of entity for one-owner businesses.
The sole proprietorship is the simplest type of business entity to form. Few legal formalities are required. Because a sole proprietorship is not incorporated, there is usually no need to file documents with the state in order to form the sole proprietorship. But if the sole proprietorship will be operated under a trade name or fictitious business name, it may be necessary to register the name with the state. State law will treat the business and the owner as a single entity.
Federal law follows state law in treating the business of a sole proprietorship as the business of its owner. The owner must report income tax on his or her personal income tax return, where they are taxed only once.
Capitalization and Contributions
Because state law does not recognize a sole proprietorship as an entity separate from its owner, there is no formal capitalization of a sole proprietorship. The assets of the owner and assets of the sole proprietorship are one and the same.
Owner Liability for Entity Obligations
Sole proprietorships offer no protection for the obligations of the businesses. The owner is personally liable for the debts, obligations, and liabilities of a sole proprietorship. This is a significant disadvantage to this type of business structure. Very few well-informed business owners operate as a sole proprietorship.
Protection of Entity Assets from Owner’s Creditors
Because a sole proprietorship is not treated separately from the owner, the sole proprietorship offers no protection for the entity assets from the owner’s creditors.
Because a sole proprietorship is not treated separately from the owner, the owner has complete control over the affairs of a sole proprietorship.
Continuity, Transferability, and Dissolution
The business of a sole proprietorship continues until the owner’s death or disability, bankruptcy, or decision to end the business. In most situations, the owner can sell or transfer the business without restriction by simply transferring the assets to the new owner. If the sole proprietorship involves a professional practice, however, the transfer may be restricted to eligible owners. Because a sole proprietorship is not recognized as separate from the owner, there is no need to dissolve the sole proprietorship when it ceases to conduct business.
Because a sole proprietorship is not treated separately from the owner, there are no laws requiring access to the business records of a sole proprietorship.
Transition to Other Entity Form
Transitioning to an incorporated business from a sole proprietorship is simple. The owner simply contributes the business assets of the sole proprietorship to the form of entity that he or she chooses in exchange for an interest in that entity.