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The sole proprietorship
is one of the most common forms of business ownership. It is primarily
defined as a business that is owned and operated by one person.
It is the least complicated form of business ownership, being the
easiest to set up and terminate. It is estimated that 85% of American
businesses nationwide are legally setup as a sole proprietorship
(1). Many new businesses start out as a sole proprietorship as the
owner is unfamiliar with the other forms of organizations (2).
| Advantages
of a sole proprietorship business structure: |
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Ownership is easy to establish (3).
There is less formality and fewer legal restrictions as compared
to other forms of establishment.
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Owner controls all of the money made
by the business (4).
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Owner makes all the decisions (5).
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For small operations the owner supplies
all the management as well as labor.
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Owner is the manager for the business,
and thus can make day to day decisions more quickly.
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Little or none governmental approval
is needed. It approval is needed its less expensive than a
partnership or corporation.
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There are no partners or share holders
to work with or report to.
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A sole proprietorship can be modified,
bought, sold, or terminated quickly. No public notification
is required.
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Owners are unrestricted in utilizing
the help of their children, depending upon their ages, interests,
and abilities.
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Employees can help with management
and labor without altering the nature of the sole proprietorship.
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Disadvantages
While the ease of formation and complete control over the decisions
makes the sole proprietorship very popular with many small business
owners there are potential risks involved this type of legal ownership.
| Disadvantages
of a sole proprietorship business structure: |
| Owner
is totally responsible for all business liability (debts and
obligations). Creditors can challenge any portion of the owner's
assets including real estate, and transportation. Additional
problems of liability, such as physical loss or personal injury,
may be lessened by obtaining proper insurance coverage. |
The
resource base of the business is limited. When seeking loan
money, financial institutions will be less inclined to assist
if the owner has limited personal assets. |
Owners
of sole proprietorships often make the mistake of combining
household and business finances together thus making it very
hard to judge the profitably of the business. |
| The
sole proprietorship appears less professional than a partnership
or corporation (5). It can be harder to attract high caliber
employees, or those that want to own part of the business (4).
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When
the original owner passes on, the next generation must purchase
or inherit the business assets but still pay taxes and costs. |
Sole
proprietorships are often characterized by owners having unstable
business lives. When the owner dies the business is either crippled
or terminated. |
Taxation issues
A sole proprietorship is not considered separate from its owner
for tax purposes. This means the sole proprietorship itself does
not pay income tax; but rather, the owner reports business income
or losses on his or her individual income tax return. The owner
must report the income generated (or lost) from a sole proprietorship
on an IRS Schedule C, form 1040 (Profit or Loss from a Business).
Taxes will be based on all of the profits from the business (income
minus expenses). Any money that remains in the name of the sole
proprietorship's bank account will be taxed at the end of the year.
Deductions can be made however. These will include money spent
on business startup costs, equipment purchased, yearly operating
costs, advertising costs, business meals, travel costs, and entertainment
costs related to conducting business. However the Internal Revenue
Service requires that a separate set of expenses be kept for the
business as opposed to the household. In effect the owner must keep
a separate check book for business expenses.
As the sole proprietor of a business, the owner is responsible for
setting aside enough money each year to pay the taxes on income
generated. The owner will have to estimate how much tax will be
owed at the end of the year and then make quarterly estimated income
tax payments to the IRS.
For a complete description of all the factors that should be considered
for sole proprietorship taxes refer to the IRS's Tax Guide for Small
Businesses (7).
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This nursery owner
in southwest Washington has her own small scale lavender farm
which she manages entirely on her own.
A beginning entrepreneur will put in a great number of hours
of work the first few years as the business grows. If done
carefully the rewards are very self satisfying!
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References
1. Selecting
an organizational structure for your business. 1997. Marsha
Goetting, and Alice Mills Morrow, Montana State University, MT 9708.
2. What type of business
organization is best for you? My Own Business, Inc., Rowland
Heights, CA .
3. Sole proprietorship.
MyCorporation.com.
4. Forms
of business ownership. United State Small Business Administration.
5. Pros
and cons of sole proprietorship. 2003. BusinessTown.com.
6. Frequently asked
questions pertaining to a sole proprietorship business. Internal
Revenue Service, Department of the Treasury, Washington DC.
7. Tax Guide
for Small Businesses: Publication 334. U.S. Internal Revenue
Service.
First posted:
December, 2004.
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