Choosing the Right Legal Entity for Your Startup - Exploring Sole Proprietorships

• Operate Under Your Own Name – You are not required to register a company name with the state and can operate legally under your own name.
• Business and Owner as One – All business income and expenses are claimed under your personal income tax return.
• Personally Liable – As the business owner, you are personally liable for all the actions and liabilities of the business. That means you are responsible if you subcontract any work that fails to meet your client’s needs or causes damage.
• No Need for a Business Bank Account – Since the law views you as a single entity, you don’t need to set up a business bank account. However, it is a good idea to do so.
• Perfect for an Individual – As an individual taxpayer, you can start a sole proprietorship anytime, operating under a company name or your own name.
• Works for Married People Too – As a married couple, you can also claim your sole proprietorship income on your jointly filed tax return. If you file separately, you must split everything between the two tax returns based on community and separate property rules.
• Active Until Death – Your sole proprietorship remains active until you personally dissolve it or die.

• Pass-Through Taxation – Your business income and expenses are yours personally. You get to keep any profits you make, and your income is taxed only once. The business is not taxed separately from you.
• Complete Control – You are the sole decision maker and can manage the business however you like. You do not have to confer with other people or ask anyone before making decisions about the business. Every aspect is yours to control. You don’t have to share your business profits with anyone; they are yours. You can also use those profits to pay for personal use without any penalties.
• Easy & Inexpensive to Set Up – A sole proprietorship is quick and easy to set up without any legal paperwork. You can start running your own business instantly. You don’t need to do anything if you choose to run the business under your own name. If you pick a fictitious name, you may need to file a DBA form with the state. You may have to apply for permits or licenses, but those fees will be minimal.
• Tax Deductions – Not only is tax preparation easy with a sole proprietorship, but you can also take advantage of some deductions for travel, supplies, equipment, contractors, automobile expenses, advertising, and a portion of your home expenses if you operate a business office out of the home.
• Loss Carryover – A sole proprietorship also gives you added flexibility at tax time. If you have business losses, you can apply them to other types of income and carry them forward or backward to minimize the tax impact.
• Privacy and Confidentiality – Since a sole proprietorship is not a publicly traded company, your financial information is private and confidential. Plus, if you have trade secrets, those remain yours to keep.
• Flexibility – Even if you start your business as a sole proprietor, you can always transition it to a different business structure down the road when things change. Switching business structures later is much less complicated if you start with a sole proprietorship.

• Liability Exposure – The biggest issue with sole proprietorships is that they don’t protect you personally from any liability caused by your company. You and the business are a single entity in the eyes of the law; therefore, if someone wants to sue your business, they can come after you personally, and you could lose everything, even your home. What is worse, you can also be held liable for your employees’ actions. You are personally liable for losses, debts, damages, and negligence that occurs in your business by you, your employees, and its agents. A sole proprietorship leaves you exposed. Evaluate the possibility of legal issues and risks before choosing this type of business entity.
• Credibility/Legitimacy – Some people, clients, and even government agencies view sole proprietorships as “less than” other business entity types. They carry the stigma of being less credible or legitimate and not offering the same level of professionalism as an LLC or corporation. You may have trouble obtaining specific clients due to this poor reputation. Larger companies may not want to risk working with sole proprietors because they fear that the IRS may view the person as an employee rather than an independent contractor. These laws can appear gray at times. Consider your short-term and long-term goals and your desired customer base before deciding to structure your business as a sole proprietorship.
• On Your Own – You are the sole person responsible for everything about your business. That means you make all the decisions but must also bill for your services, collect money, and pay bills. There is no one to share in the responsibility when you own a sole proprietorship.
• Less Tax Flexibility – Sole proprietorships run on a calendar year, and you are taxed on income in the year you collect it. Unlike other business entity structures, you cannot apply profits to a future year and then pay yourself later. You are taxed on the income when you earn it. The lack of flexibility may hinder your ability to take advantage of tax benefits.
• Harder to Raise Capital – Unfortunately, lenders are less likely to take a risk on you as a sole proprietor due to the unlimited liability and risk factor of getting paid back since the entire business rests on one person’s shoulders. Even if you can secure financing, you may be limited by how much you can borrow, and you might face higher interest rates or worse terms than other business types.
• Limited Selling Options – When it comes time to sell the business, you may have difficulty because it is so tightly integrated with you. Your business finances and persona are combined, so determining the business’s value may be challenging, as well as transferring assets. Another issue is customer loyalty. Your clients may love you but may not want to deal with someone new, so if you sell, the business could be viewed as worthless.

When you file your personal 1040 form at tax time, you will report your business income and expenses, but you will also include supporting documentation that details the line items. One of these is Schedule C, which subtracts your expenses from your income to determine your profit or loss. That figure is then carried to your 1040 form and added to any other income you earned. You must report all income regardless of where it came from. Some of the forms you will use to report your income are 1099-MISC, 1099-INT, 1099-NEC, and 1099-K. Some of the allowable expenses you can report on your Schedule C include:

• Advertising
• Commissions/Fees
• Depreciation for Equipment or Buildings
• Cost of Goods Sold (COGS)
• Business Insurance
• Interest
• Mortgages
• Legal Fees
• Rent
• Repairs/Maintenance
• Supplies
• Taxes
• Licenses
• Utilities
• Wages/Contractor Fees