As a new business owner, you are undoubtedly aware that there are many ways it can be structured. A sole proprietorship is the simplest business to form and operate; however, often a Limited Liability Company, or “LLC,” is preferable because it provides for the liability protection of a corporation and the tax advantages of a partnership. One of the key perks of an LLC is that it separates the business from the individual both financially and legally. In a sole proprietorship, your assets and the business assets are not legally separate, thus your home, your car, even your personal bank accounts are exposed to creditors of your business. As the owner of an LLC, your liability is limited to the amount of your investment in the business (assuming you have not personally guaranteed any debt).

As your business grows, you may want to take on additional partners or delegate roles and responsibilities. Forming an LLC initially, with clear and predetermined terms, can help minimize the risk inherent in sharing control of your business. Banks and other creditors, suppliers and even significant customers may be more likely to do business or provide better terms to an LLC. Operating as an LLC also ensures that your business will be the only business with that name in the state in which it is registered. Ultimately, the choice depends on your individual facts and circumstances and you should consult your accountant and legal counsel to go through the specifics of your business.

What is a Sole Proprietorship? Advantages and Disadvantages

A Sole Proprietorship is a type of business entity with a single owner, having the perk of being very simple to start. Just pick a name—yours or a fictitious name (also known as ‘doing business as’), get the licenses you need, and you’re ready to go. Sole Proprietorships also get the advantage of being a ‘pass-through entity,’ which eludes the double taxation you’d get from owning a regular C-corporation. It’s easy, simple, and avoids unnecessary taxes;

Sole Proprietorship Advantages and Disadvantages

Sole proprietorships are popular among independent contractors, consultants, and other small business owners. A sole proprietorship is not a separate entity from its owner and doesn’t yield to a lot of government regulations. Let’s cover the advantages and disadvantages of starting a sole proprietorship:

Advantages of a Sole Proprietorship:

  • Full control of Business; sole owner.You alone call all the shots; make all decisions; have the final say, in all aspects of your business.
  • Sole proprietor receives all profits.As a sole proprietor, all the profits in your business flow directly and solely to you.
  • Access to business loansThough unincorporated, a Sole Proprietorship is a business entity and has access to business loans. However, you will be personally liable for all debts to creditors.
  • Simple and easy to startNo state filings, no state annual reports, few formalities, less fees; Register a name, get your license, and go!
  • Easy record-keeping requirementsRecord keeping is relatively straight-forward when you’re the sole owner and funnel for all income and expenses.
  • Being a Pass-through Entity; Better Tax RatesOwners of a sole proprietorship don’t have to file both business and personal taxes (read more on taxes below)

Disadvantages of a Sole Proprietorship:

  • Unlimited Liability; You May Lose Your Personal AssetsUnlike a Corporation or a Limited Liability Company (LLC), Sole Proprietorship owners are personally responsible for all debts and claims against their business. If anyone wanted to take legal action against an LLC, they could only sue the business entity, not the owners. A Sole Proprietor lacks liability protection and risks losing their personal assets.
  • Taxes (Read more on Sole Proprietorship Taxes below)There’s no contrast between personal and business income from a tax perspective. The tax rates for income from a Sole Proprietorship depend on individual tax bracket.
  • Hard to Raise MoneyBusiness Lenders typically prefer to work with ‘limited companies’, partly due to a Sole Proprietorships lack of shareholders, partners, and members. You also can’t raise capital by selling an interest or share in the business. If you need to raise money for your business, check out our services.

Sole Proprietorship Taxes

A sole proprietor reports the earnings of his or her business to the IRS as personal income. You must file Schedule C (Form 1040)—along Schedule SE to determine how much self-employment tax you owe. The IRS requires you to pay unemployment tax for your employees, but not yourself; which unfortunately means that you won’t get unemployment if the business flops.

Sole Proprietorship Tax Rates and Tax Bracket

The tax rates for the income of a Sole Proprietorship will depend on the owner’s tax bracket. For example, if your Sole Proprietorship profited $550,000 after expenses—even if you only paid yourself $100,000—you will still be in the 37% tax bracket, not the 22% (according to 2019 rates). Making you pay more in unnecessary taxes!

LLC vs Sole Proprietorship

The difference between a sole proprietorship and a LLC:

A Limited Liability Company (LLC)—unlike a Sole Proprietorship—provides its owners with liability protection. The company is an entity separate from its owners and responds to any debt, claims or legal action with company assets; protecting personal assets. An LLC even has the ‘pass-through’ or ‘flow-through’ tax treatment of a Sole Proprietorship; avoiding the double taxation of a C-corporation.

It’s also easier to raise capital as an LLC since lenders prefer working with them over Sole Proprietorships. If you work from home or use personal assets for your business, you could have the LLC lease the home office or other assets from you; enabling you to write off the use of personal assets as business expenses.

S-Corporation vs Sole Proprietorship

Unlike a Sole Proprietorship, an S-Corporation has limited liability; which protects the owner. Like a Sole Proprietorship, an S-Corporation has pass-through tax treatment; avoiding double taxation. However, since a Sole Proprietorship is not a separate entity from its owner, both your personal and business incomes are counted as one towards determining your tax bracket. Unfortunately, this may typically result in a Sole Proprietorship having higher tax rates than an S-Corporation

Thanks Spiegel & Utrera, P.A.  for the original content and services you provide to some our of clients


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