Legal Definition Sole Proprietorship
A sole proprietorship exists when one person owns all of a business. Such businesses often consist of simply that one person, although they might have a few employees. In a sole proprietorship, all of the business responsibilities, including debts and expenses, belong to the owner.
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Why It's Not a Company
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When several people get together to form a company, usually each of them owns a portion of that business and is entitled to a portion of the business's stock or profits. Often, the group will incorporate or become a limited liability partnership or LLP, creating a separate legal entity from the individuals themselves. That way, if the company is sued, the individuals themselves are not liable. Further, the company or LLP, not the individuals, pays taxes on its profits. To some degree, the personal property of the owners cannot be seized to pay off the company's debts.
A sole proprietorship is the exact opposite. There are no partners, and if the company is sued, the owner is liable for any judgments rendered. If Joe Smith is a sole proprietor and his business is being sued, then Joe Smith is being sued.
A sole proprietor pays taxes on the business simply by paying individual earned income tax. If the business accrues debts, then the sole proprietor's personal assets, such as a home or a car, can be fair game for creditors.
Forming a Sole Proprietorship
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Most sole proprietorships are very small businesses, and as such do not require any legal documentation to be filed. However, some counties or states might require a person to register the name of a business differs from the owner's name, or to file a "doing business as" statement.
For the reasons stated above, it is important not to use "company," "incorporated," "limited" or similar terms in the name, as legally they would be untrue.
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Advantages
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There are many advantages to a sole proprietorship. The sole proprietor is not beholden to other business partners to make decisions, and all managerial decisions are up to her. The business can be sold or bought at the owner's discretion, and there is less of a tax burden on profits.
Disadvantages
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Disadvantages include the risk of sole liability in the event of being sued. And although insurance can be purchased to cover equipment or sometimes employee health care, there is no insurance available to cover profit loss for a sole proprietorship. Also, personal property can be seized if the business accrues too much debt.
General Tips
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Sole proprietorships are a good idea for people who provide a for profit-service on the side or in addition to a day job, such as a person who works as a handyman on weekends, or a homemaker who repairs vacuum cleaners on occasion. They are best suited to businesses that have a low likelihood of being sued, of having to borrow a lot of money, or of on on-the-job injuries.
However, a sole proprietorship is still a business, so business earnings or write-offs need to be taken into account when the owner files his personal income tax.
It is a good idea to maintain a separate checking account for business transactions and to have excellent records on hand at all times.
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References
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