What is a Sole Proprietorship?
The sole proprietorship is the simplest and most common form of business structure. Many businesses begin as sole proprietorships and graduate to more complex business forms as they develop.
A sole proprietorship simply refers to a person who owns the business and carries on the business as the sole owner. It is not a legal entity and there is no legal separation between the business and the owner. This is the distinguishing characteristic between it and an incorporated business or a partnership, which are both legal entities, separate from their owners.
As there is no legal separation, the owner will sign contracts in his or her own name and hold bank accounts in his or her own name.
Formation and Dissolution of a Sole Proprietorship
A sole proprietorship is easy to form. In some jurisdictions, it does not require any formal filing of documents or events. It is a status that arises automatically from the owner's business activity of buying and selling goods or services. In other jurisdictions, a sole proprietorship is created by registering the business name with the appropriate authority.
Equally, a sole proprietorship is easy to dissolve - it just involves the cancellation of the registered business with the appropriate authority, after:
Taxation of a Sole Proprietorship
Taxation of a sole proprietorship is simple because the income earned by a sole proprietorship is the income earned by its owner. And because there is no corporate tax, profits from the business flow directly to the owner’s personal tax return.
There are some advantages to this tax liability. Firstly, the authorities tax the business profits at the sole proprietor's marginal tax rate. This is often lower than the corporate tax rate.Secondly, other income of the proprietor can offset business losses.
On the other hand, tax liabilities for sole proprietorships are not as flexible as they are for incorporated companies. This is because the owner must report all business income as regular income in the year in which it is earned. Incorporated companies have greater flexibility in how and when to pay the owners.
Liability of a Sole Proprietorship
Sole proprietors are personally liablefor all debts of the business. This means that if the business fails and incurs debts, the owner's assets (including his or her home and any other asset registered in his or her name) could be seized to discharge the debts and liabilities of the business.
In this crucial respect, a sole proprietorship is different from an incorporated business, limited company or partnership.For these latter entities, there is a legal separation between the business and its owners. This separation protects the personal assets of the owners from seizure to meet debt obligations or liabilities.
The advantages of a sole proprietorship are:
The disadvantages of a sole proprietorship are:
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