Going It Alone with Sole Proprietorships - dummies

Going It Alone with Sole Proprietorships

A sole proprietorship is, basically, the business arm of an individual who has decided not to carry on business activity as a separate legal entity (as a corporation, partnership, or limited liability company). This is the default when you don’t establish a legal entity.

A sole proprietorship is not a separate entity; it’s like the front porch of a house — attached to the house but a separate and distinct area. You may be a sole proprietor of a business without knowing it! An individual may do house repair work on a part-time basis or be a full-time barber who operates on his own. Both are sole proprietorships.

If you regularly provide services for a fee or engage in any business activity whose primary purpose is to make profit, you are a sole proprietor. If you carry on business activity to make profit or income, the IRS requires that you file a separate Schedule C, “Profit or Loss From Business” with your individual income tax return. Schedule C summarizes your business income and expenses.

As the sole owner (proprietor), you have unlimited liability, meaning that if your business can’t pay all its liabilities, the creditors to whom your business owes money can come after your personal assets. Many part-time entrepreneurs may not know this or may put it out of their minds, but this is a big risk to take. For example, if a sole proprietor is sued for giving bad advice, all their personal assets are at risk — though they may be able to buy malpractice insurance to cover these losses.

Obviously, a sole proprietorship has no other owners to prepare financial statements for, but the proprietor should still prepare these statements to know how his or her business is doing. Banks usually require financial statements from sole proprietors who apply for loans.

One other piece of advice for sole proprietors: Although you don’t have to separate invested capital from retained earnings like corporations do, you should still keep these two separate accounts for owners’ equity — not only for the purpose of tracking the business but for the benefit of any future buyers of the business as well.