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A sole proprietorship is one way you can set up your business. It’s also the most common, because there is no distinction between you and the business. As an example, consider a local photography company. The owner may be the only employee and may work out of the home. It would be normal for that person to be a sole proprietor.
To form a sole proprietorship, you don’t need to do anything special legally. You need to register your business, and then as you are the owner, you automatically assume the status of a sole proprietor. You should make sure you get the legal permits and licenses required to run your business, so you are following local, state and federal laws.
Sole proprietorships have benefits when it comes to tax season. For one thing, it’s easier to file your taxes, because you can generally file a normal 1040 tax return with only an added Schedule C form. You may have to pay estimated taxes in advance if you earn enough from your business, so make sure you understand how your earnings will affect your taxes in the long run. Also, there is no need to hire an accountant so the company can file its own separate tax returns nor is there a need for it to pay its own taxes.
While the sole proprietorship is simple to set up, there are many downsides. First, it is much harder to get investors or loans. Banks may be hesitant to provide you with loans due to a lack of credibility and no way to get the money back if your business fails. Investors generally want a percentage of ownership and for that you need a corporation, limited liability company or partnership. Most importantly, as a sole proprietor you have unlimited liability. You alone are responsible for debts and obligations that you take on, even if your business struggles. Creditors of your business can try to recover from your personal assets like your home. A business structure like a corporation or LLC shields your personal assets from the debts and liabilities of your business.
For all but the smallest businesses, it is worth the time to consult with a legal professional about the value of setting up a separate legal entity, such as a corporation, for your business.
Source: U.S. Small Business Administration, “Sole Proprietorship,” accessed July 31, 2015