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How to Incorporate - Sole Proprietorship

The term “sole proprietorship” means that the business is the same as its owner.  The assets and liabilities of the business are one and the same as the owner.  No entity is created; the business is destined to the same financial fate as the owner since they are one and the same.

Advantages

• No entity filing requirements – business starts when the owner exercises initiative.
• Simple to operate since the owner makes all of the decisions.
• May register a trade name to promote its products and services.
• Files one tax return – the owner reports and pays all taxes personally.

Disadvantages

• Unlimited Liability – The owner is personally responsible for all business losses and must bear them to the full extent of available personal resources. The proprietor is personally liable for all business debts.
• No continuity of life – if the owner dies the business transfers to the heirs for continuation, restructuring or closure.  There may also be estate tax and probate consequences depending on how large the estate is.
• You cannot give away portions of your business (gifting to family members) unless you restructure.
• Limited Financing – personal contributions by the owner, bank loans (usually with personal assets pledged as collateral) or other private sources.
• IRS Audits - sole proprietors tend to have the poorest record keeping habits, often mixing business and personal finances, which makes them a prime target for the IRS.
• Converting to Corp or LLC – since the new entity will have a new taxpayer identification number (EIN) you get to set up your business all over again.  Licenses, permits, bank accounts, accounting, payroll, vendor accounts, invoices etc. all need to be established under the new EIN and all documents, stationary, business cards, advertising, marketing, and logo must designate your new identifier which may be Inc. or LLC after the company name.

Tax Implications

• Business income and expenses are reported on a separate “schedule” attached to the sole proprietor’s annual Form 1040 individual tax return.  
• All of a sole proprietor’s net profits are subject to “self-employment” tax (15.3% for Social Security and Medicare). This is equivalent to the payroll tax for employees.
• Required to make income tax payments, called “estimated taxes,” four times a year.