Question: Advantage and Disadvantage of Sole Proprietorships
Advantages of Sole Proprietor Form
The advantages of forming a sole proprietorship include:
As the sole owner of the business, you have complete control over all the operations, and you get to make all the decisions. You don't have a board of directors, shareholders, or other owners to answer to.
Tax Preparation and Filing
Sole proprietorship income taxes are easy to file, using Schedule C and adding the income/loss from the business to your other income on your personal tax return.
According to the Small Business Administration, sole proprietorship tax rates are the lowest of any business form (13.3 percent tax rate as compared to 26.9 percent for S corporations).
Use of Losses
Because you are including your sole proprietorship income/loss on your personal tax return, you can use any business losses to offset personal income from other sources (a spouse's salary, for example). You do need to be careful not to run up against the IRS restrictions on "hobby" businesses which generate losses for years, but if you can prove your business is legitimate and not a hobby, those losses can lower your taxes.
Disadvantage of the Sole Proprietorship
The primary disadvantage to a sole proprietorship is that your personal finances and those of your business are one and the same. You cannot file bankruptcy for your business without filing personal bankruptcy. You cannot expect to shield your personal assets from liability for the debts of the business, nor can you avoid being sued personally for negligence due to some problem with your business.
For example, if your sole proprietorship cannot pay its bills, your personal credit card will probably come into use. And filing bankruptcy for your sole proprietorship, whether it is a reorganization (Chapter 11) or liquidation (Chapter 7) means involving your personal assets. As stated by the U.S. Courts website (in the Chapter 11 section): "a bankruptcy case involving a sole proprietorship includes both the business and personal assets of the owners-debtors."
For many business people, the issues of personal liability and involvement of personal assets outweigh the advantages of sole proprietorship structure. If this is the case with you, consider forming a limited liability company (LLC) or corporation.