The Sole Proprietorship as the Legal Structure for Your Small Business

The decision you make for the type of legal structure in operating your small business is probably the most important one relating to taxes.

This decision will also affect:

1.  The amount of paperwork you will be required to do

2.  Your personal liability

3.  Your ability to raise money for your small business

If you decide to begin your small business as a sole proprietorship and later decide to add partners you can change to a partnership or other entities.  If and when you do this you will be obligated to inform your state tax agency and the IRS.

If you are the only person who is going to own and operate the small business the sole proprietor ship may be the best way to go, at least initially.

It is by far the simplest legal structure in which to operate mainly because of the tax aspects.  The tax aspects of this form of structure for your small business are compelling ones, because the expenses and the income from your small business are included in your personal tax return.  The really good thing about the sole proprietorship is that business losses you suffer may offset any income you have earned from other sources.

At tax time each year, as a sole proprietor, you must also file a schedule SE with form 1040.  The schedule SE is used to calculate how  much self employment tax you owe.

You must also make estimated tax payments (4 equal payments on your estimated taxes for the year on the 15^th day of April, June, September, and January) if you expect to owe at lease $1,000 in federal taxes for the year and your withholding will be less than the smaller of:

1. 90% of your current year tax liability or

2.  100% of your previous year’s tax liability if your adjusted gross income (AGI) is $150,000 or less (or $75,000 or less if you are married and filing separately).

Are you confused yet?  I am always confused at tax time, so don’t feel badly.

Most small business owners employ a good CPA to handle these things at tax time.

The big plus in a sole proprietor structure for your small business is that you will have complete control  over your business.  You will make all the decisions.  If you are one of those folks in the habit of blaming someone else if your small business does not do well, then you should certainly shy away form this type of legal entity!

But, in a sole proprietorship your small business earnings are taxed only once, unlike some of the other business structures available to you.

The disadvantages of the sole proprietorship structure for your small business are:

1.  Banks and other traditional lenders may be hesitant to make business loans to small business owners who select this form of legal structure.  Raising money for your operation will be harder.

2. In a sole proprietorship you are personally responsible for your company’s liabilities.  Your personal assets are not safe because they could be seized to satisfy debts incurred by your small business or any other legal claim against you.

The legal structure you decide to use for your small business is an important one.  You should ask your financial advisors; i.e., CPA, Attorney, Financial Advisor for their advise before making this critical decision for your small business venture.  Good Luck!