Chapter 2 – Sole Proprietorships

Concepts

• Sole Proprietorships – A business owned and operated by one person
• ADVANTAGES
  • Easy to form and maintain
  • Inexpensive to form
  • Owner is sole decision-maker
  • Management is informal and flexible
  • All profits are retained by owner
  • Pass-through tax status
• DISADVANTAGES
  
  • Unlimited personal liability
  • Limited ways of raising capital
  • Lack of continuity
  • Possible lack of expertise in management
• Personal Liability – Liability extending beyond what is invested in a business to an individual’s personal assets (also called unlimited liability)
• Lack of Continuity
  • Because the sole proprietorship is merely an extension of the sole proprietor, the sole proprietorship generally terminates with the death of the sole proprietor. 
  • If the business assets descend to an heir who continues to operate the business, a new sole proprietorship has been created.
• Capital – Money used to form and operate a business or other venture
• Difficulties in Raising Capital
  • The sole proprietor is limited in his or her ways of obtaining additional money.
  • The sole proprietor can look only to his or her own funds or can attempt to borrow money.
  • If banks or other parties do not believe the business has a proven track record, they may refuse to lend funds, and the sole proprietorship may collapse.
• Management Difficulties
  • The sole proprietor has the flexibility of making all management decisions; however, this can sometimes be a disadvantage.
  • The sole proprietor may need to expend funds to hire outside consultants and advisors.
• Formation of Sole Proprietorships
  • One of the greatest advantages of a sole proprietorship is the lack of formalities in organizing and forming this enterprise. Most of the requirements for forming the sole proprietorship are common to almost any business.
    • Licensing considerations
    • Name considerations
    • Business and Sales Tax Permits
• Name Considerations
  • Fictitious name:  a name that must be registered with state or local officials because it does not disclose the surname of the business owner
  • DBA:  ‘‘Doing business as’’; another name for a fictitious business name statement
  • Fictitious business name statement:  record filed with public officials to identify the owner of a business operating under a name other than the owner’s surname
• Taxation of Sole Proprietorships
  
  • Because the sole proprietorship itself is so closely identified with the individual operating it, it is not recognized as a separate taxable entity as is a corporation.
  • Thus, the sole proprietorship itself does not pay any federal income tax.
  • Income derived from the sole proprietorship is simply added to any other income the sole proprietor, and the sole proprietor pays tax on this entire amount.
• Key Features of Sole Proprietorships
  • Business is owned and managed by one person
  • Sole proprietor retains all profits and bears all losses
  • Sole proprietor’s personal assets can be reached to satisfy business obligations
  • Business is easily and inexpensively formed
  • All income earned (and loss incurred) is passed through to sole proprietor, who pays tax at appropriate individual tax bracket