What Makes a Sole Proprietorship So Unique?
The Sole Proprietor vs. Other Business Owners
The sole proprietor business is by far the most common business type in the U.S. There are 23 million sole proprietorships today, compared to 1.7 million traditional corporations and 7.4 million partnerships and S corporations, according to the Tax Foundation.
Yet, the sole proprietorship business is still somewhat of a mystery, in part because there is confusion about the different business types. This article specifically discusses the sole proprietor as a business owner, compared to partners in a partnership, limited liability company members, and corporate owners (shareholders)
The Most Important Thing to Know About Sole Proprietorships
A sole proprietorship is a business that is owned by one person, and the business is not legally separate from the owner. A sole proprietorship is not formally registered with any U.S. state as a separate legal entity (an individual, company, or organization that has legal rights and obligations). Since the sole proprietorship is not separate from the owner, the business and the owner are joined together (not separate) for purposes of liability, profits and losses, and debts.
Is a Sole Proprietor The Same as Being Self-Employed?
Being self-employed means owning your own business. Partners in partnerships and members of a limited liability company (LLC) are self-employed for tax purposes. Owners of a corporation are shareholders, not self-employed business owners.
All sole proprietors are self-employed but not all self-employed people are sole proprietors.
How a Sole Proprietorship Differs from Other Business Types
1. Number of Owners
A sole proprietor is a solo business owner. If you are a sole proprietor, you are the only person who owns your business. A partnership by definition has more than one partner, and a corporation usually has more than one shareholder. A limited liability company (LLC) may be owned by just one person (called a single-member LLC), but this business must register with a state.
The ownership of a sole proprietor business is direct and simple; there are no shares of stock (corporation), partnership percentages (partnership), or member shares (LLC).
An Exception to the One-Owner Sole Proprietorship
Spouses in a partnership business together can elect to file taxes as a Qualified Joint Venture (QJV), which means they each file a Schedule C (the same as a sole proprietor) to report business income, based on their share of the net income of the business. The QJV option has requirements and qualifications, and some partnerships filing as LLCs can't take this option.
2. Control by Owner
A sole proprietor has complete control of his or her company. Since there are no other owners, and no legal agreement restricting ownership, the sole proprietor can whatever is necessary to keep the business going. In a partnership or LLC structure, ownership is designated by an agreement (Partnership agreement or LLC operations agreement). In a corporation, control over the company rests with the board of directors, of which body the original owner has only partial control (even if he/she has a controlling interest.
3. Startup of the Business
A sole proprietor business is the easiest to start. You don't need to register the business with your state or have a board of directors or operating documents (like a
Starting a sole proprietorship means opening a business bank account, maybe filing a fictitious name statement with your city or county, and
4.Tax and Legal Status
A sole proprietor is unique because nothing is needed to form this business type. If you want to be a sole proprietor, you just start your business. No legal documents need to be filed.
A sole proprietorship files taxes on Schedule C of the owner's personal tax return and the income from the sole prop is taxed at the owner's personal rate. A single-member LLC may be taxed as a sole prop, while a multiple-member LLC is taxed as a partnership. Partnership income is taxed to the partners at their personal tax rates. Finally, the owner (shareholder0 of a corporation is taxed on any distribution from the company and on dividends paid to the shareholders; the corporation pays taxes at the corporate rate.
5. Liability of the Owner
As noted above, the sole proprietor is liable personally for the debts of the business and for negligence and other personal liability. In the LLC and corporate forms of business, the liability of the owner is limited to the owner's investment.
As you can see from this discussion, a sole proprietorship is connected to the owner's personal taxes and part of the owner's liability. The control and flexibility of the sole proprietor is balanced with his or her liability for anything that can be a problem within the company.
6. Continuing Existence of the Business
Because a sole proprietor business is co-existent with its owner, if something happens to the owner, the business cannot continue. In contrast, with a partnership or LLC, if something happens to one owner, the business can continue. In a corporation, ownership is not tied to the day-to-day operation of the business, so if one owner (shareholder) leaves the company, nothing much changes.
Still Confused about Business Types?
This article sorts out the pros and cons of different business types. Before you decide on a business type, discuss your options with both a tax professional and an attorney.