Why the Sole Proprietorship is the Simplest and Riskiest Entity
Five Part Blog Series on Business Entities, Blog 1 of 5
By: Janet Behm, Enrolled Agent
4-Minute Read Time
- THE LAUNCH
- KEY FEATURES AND MINIMAL COMPLIANCE
- OF COURSE, THE TAXES
- THE MAJOR ISSUE: NO LIABILITY PROTECTION
- PROS & CONS
- BOTTOM LINE
THE LAUNCH
Jackie, Lynn’s late wife, worked for U.S. West Communications (formerly Mountain Bell Telephone). She took a ‘Golden Parachute’ offer to retire early.
This deal funded a start-up business as a manufacturer’s representative. It was just her. No sales, no revenue, so a Sole Proprietorship was how she started.
When launching a new business, side hustle, or freelance career, many start without formal paperwork, making the Sole Proprietorship the easiest option. This structure's main appeal is that you can begin operating without prior registration.
For tax purposes, a sole proprietorship uses Schedule C (Form 1040) to report profit or loss from the business. If you run a business under your own name or a DBA ("Doing Business As"), you are considered a sole proprietor. Independent contractors or freelancers who receive Form 1099-NEC or 1099-MISC generally report that income on Schedule C. Even small earnings or losses require Schedule C filing if you earned $400 or more in net income.
KEY FEATURES AND MINIMAL COMPLIANCE
The main advantage of the sole proprietorship is its minimal compliance burden. You do not need a formal entity like an LLC or a corporation to file Schedule C.
Simple as this may be, you must run your business with a profit motive (hobbies don't get tax breaks).
You must keep accurate records of income and expenses, which are essential for managing your business and preparing taxes effectively.
You may also need specific local business licenses or permits, even if you don't register as a formal entity.
OF COURSE, THE TAXES
Taxation: The Double Hit of SE (Self-Employment) Tax.
Net profit from Schedule C is subject to two major taxes:
- 1. Income Tax: The profit is added to your personal income and taxed at your ordinary personal income tax rate.
- 2. Self-Employment (SE) Tax: The profit is also subject to the full rate of Self-Employment Tax (Social Security and Medicare), which is approximately 15.3%.
On the flip side, any business losses can offset other personal income, potentially reducing your overall tax liability.
THE MAJOR ISSUE: ZERO LIABILITY PROTECTION
The most significant issue with the sole proprietorship is the complete lack of a liability shield.
In this structure, you are the business; there is no legal separation between the owner and the business. This means that, unlike an LLC (Limited Liability Company),a sole proprietorship offers no liability protection, putting your personal assets—like your house, savings, or retirement accounts— at risk if your business faces debts or lawsuits.
PROS AND CONS
Pros (Schedule C)
- Simplest structure; no formal registration required
- Income and loses flow directly to personal return
- Losses can offset other personal income
Cons (Schedule C)
- NO Liability Protection: Personal assets are at risk
- All net profit is subject to the full 15.3% Self-Employment Tax
BOTTOM LINE
If your business has minimal risk of lawsuits or debt, and you prioritize simplicity above all else, Sole Proprietorship is the easiest way to start. However, as soon as you have meaningful assets or engage in activities that carry liability risk, moving to a formal entity is essential to protect yourself.
BE THE ROAR not the echo®
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