When starting a new business it is quite difficult for business owners to decide if they should keep trading as themselves or register a business. Would it be more costly to register an LLC? And what are the benefits of just trading as a sole trader? In this article we look at what is a sole proprietor, what are the advantages and disadvantages of a sole proprietorship and our recommendation of should one rather register an LLC or keep trading as a sole trader.
What is a sole proprietor and a sole proprietorship?
A sole proprietor is the exclusive owner of a business. A sole proprietor is entitled to keep all the profits of a business, however, they are also responsible for all the liabilities and debts.
A sole proprietorship is a business owned by one individual and is also known as a sole trader, individual entrepreneurship, or proprietor. Examples of sole proprietorships are artists, independent contractors, freelancers, tutors, and musicians to name a few. Sole proprietorships are low profit/low-risk entities. How do I form a sole proprietorship in the USA?
In many states one does not have to register or do any filings to form a sole proprietorship. One can simply start trading under your own name.
What are the tax implications of a sole proprietorship?
The profits and losses of the sole proprietorship will flow through the owner. All profits and losses have to pass-through taxation, the owner’s individual tax returns have to reflect the income and expenses. Sole proprietors have to pay self-employment tax. A sole proprietorship can get an EIN number for when it employs other individuals and has to pay over employment taxes to the IRS.
What are the legal implications of a sole proprietorship?
Legally operating as a sole proprietorship business the owner is not separated from the business. A sole proprietor signes checks, contracts and lease agreements in its own name. Payments to proprietorships are also made to its owner’s name. An owner of a sole proprietorship is entitled to 100% of the profits, however the owner is also 100% liable for the debts and liabilities.
What are the advantages of a sole proprietorship?
The advantages of a sole proprietorship is that it is easy to start and the owner does not need any money upfront to start or form the sole proprietorship. The other advantage is that entrepreneurs can test their business ideas first through a low risk sole proprietorship before making the decision to register an LLC. Should the business fail in the early stages it is much easier to stop trading as a sole proprietor than an LLC. These are basically the only advantages a sole proprietorship offers the owner.
What are the disadvantages of a sole proprietorship?
The disadvantages are that a sole proprietorship offers the owner no protection for personal liabilities. All the owner’s personal assets are at risk should the business be sued or defaults on their debt. As a sole proprietor, there aren’t any tax benefits, the owner will pay taxes on all profits as well as full FICA taxes. When the business becomes very profitable the taxes will become very expensive.
The other disadvantage of a sole proprietorship is that the growth potential is limited. The more profitable the business gets the more risk there is to the owner’s personal assets. A formal business structure will be sought after some time. Another disadvantage is that a sole proprietor has less credibility and branding options, all will be in the name of the owner.
Conclusion
The disadvantages definitely outweigh the advantages of a sole proprietorship. It might be best to form an LLC as soon as the owners are positive that the business has an efficient market. LLC’s offer owners limited liabilities and many tax benefits.
As a sole proprietor keep the business small and limit the risks of the business. TRUiC provides very helpful information on their website regarding sole proprietorships and when to register an LLC.