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Olsen Skoubye & Nielson, LLC
999 Murray Holladay Road, Suite 200
Salt Lake City, Utah 84117
(801) 365-1030 (phone)
(801) 365-1031 (Fax)
info@osnlaw.com
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Sole Proprietorship
A sole proprietorship is the simplest form of business entity. It requires no formal organization papers or formalities for conducting the business. Essentially, the individual functions as a business and is liable for all of the debts and liabilities incurred in conducting it.
A sole proprietorship is generally considered an "informal" business organization. That is, it does not require any formal documentation or state filings to legally create it. It is a single individual conducting business in his or her individual capacity. Usually a d.b.a. ("doing business as") or an assumed name will be used for conducting the business.
To create a sole proprietorship the individual simply obtains the necessary business licenses, tax numbers if necessary, and perhaps registers a name. Then the individual conducts the business, making all decisions for the company and receiving all of the profit. Employees may be hired and business assets purchased and disposed of. There are no required annual reports or meetings. If the business is sold, it is treated as a sale of the assets of the business, not as the transfer of the business itself. Therefore, gain or loss on sale is determined on an asset by asset basis.
As a sole proprietor, the business owner is personally liable for all of the debts, obligations, and liabilities of the company. All assets of the company are the individual's assets since a separate entity does not exist. No separate tax return is filed. The individual completes a schedule C to account for the income and expenses of the company and claims all income or loss on his or her individual tax return. The sole proprietor also files a schedule SE for self employment taxes. Quarterly estimated tax returns must be filed to avoid tax penalties.
The sole proprietorship is often the entity of choice for small startup businesses due to its simplicity and lack of formalities. This is clearly its strength. Its lack of separate structure is also its weakness, however. Since no separate entity exists, there is no shielding of the proprietor from the liabilities of the company. Depending on the type of business conducted, this may be more or less of a concern. Any individual who deals in the buying, selling, or leasing of real estate in his or her own name should consider some other form of doing business. Over recent years, liability for contaminated property has raised grave concerns for those in the chain of title on real estate. The liability for cleanup is not limited to those who caused the contamination but extends generally to all owners in the chain of title.
Leasing property to others can also be risky business where limited liability should be sought. Case law is replete with plaintiffs suing landlords for liability based on the conditions of the property and personal injuries that arose out of that condition. Whenever a business has substantial liability risks, a proprietorship is not the best choice.
From a tax planning perspective, the sole proprietorship provides little opportunity for tax relief. Business expenses can be offset against business income, however, all income over expense is considered self employment income and subject to the self employment tax. As any small business owner will tell you, it is self employment tax that is the major tax problem. Some deductions, such as health insurance, are also limited for a sole proprietor though this is changing. Other types of business organizations have greater flexibility in tax planning in most cases.
In summary, sole proprietorships are ideal for small startup companies having a single owner with activities that raise few liability risks and few tax avoidance needs. Individuals "testing the water" can do so without the startup costs associated with other business organizations, and yet move to a more sophisticated organization as the business shows promise. However, in most cases, a formalized business structure can save significantly on both tax liability and avoid liability as well.