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The Basics of Sole Proprietorships

Businesses often start out as sole proprietorships simply because it is the simplest entity type with the easiest setup. Unlike other business structures, no formal set up is involved.  An individual who begins to operate a business is a sole proprietor by default.  However, sole proprietorships only work if there is one owner.  If there are two or more owners, the business must be a partnership or some form of corporation.

Sole proprietorships are called pass-through entities because all business income and losses are reported on the business owner’s personal tax return rather than on a separate business return. Profits and losses are reported on Schedule C, which is submitted with Form 1040. Following are specific rules that affect the taxation of sole proprietorships:

Once the business reaches a certain level of profitability, the business owner may choose to restructure the business. The most common way to do so is to set up a Limited Liability Company or LLC for short.  LLCs require a formal document to set up, and provide the owner with personal liability protection.  However, LLCs do come with additional rules.  For example, personal and business assets cannot be co-mingled in an LLC, or personal asset protection may be lost.  Becoming an LLC does not change tax filing as long as there is only one owner.  There are additional considerations when setting up an LLC or other entity for your business, so be sure to contact a legal professional.

 

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