Business Entity: Sole Proprietorship

In terms of starting and maintaining a business, a sole proprietorship is probably the easiest and least expensive entity choice. After checking and meeting local laws, an individual can begin a business with no initial cash outlay.

If an individual is going to use a name other than his/her own, most states require that the business file under an “Assumed” Name. By meeting the “Assumed Name Act” requirements, an individual is allowed to operate his/her business under a name other than his/her own. For example, if Tom Smith wants to open a business titled “Tom Smith Computer Repairs,” an assumed name is probably not needed. However, if he wants to open a business called “Expert Computer Repairs,” he will probably need to file under the Assumed Name Act.

An advantage of filing for an Assumed Name is that the filing gives the individual legal standing for that name. This legal standing will allow the individual to seek legal action against anyone who uses the same name after the name has been legally recorded.

Advantages of a Sole Proprietorship:

  1. Children under the age of 18 whom are working for a parent, are not subject to social security or Medicare withholding
  2. Spouses working for their spouse and children under the age of 18 working for their parents are not subject to Federal Unemployment Taxes (and in most cases state unemployment taxes).
  3. Spouses working for their spouse can have family health insurance provided by their spouse/employer which COVERS the spouse/employer and be totally deductible by the spouse/employer (Note: this must be a true employee/employer relationship). Normally this is true, provided that family health insurance coverage is also offered to all other qualifying employees.
  4. If the individual is not married, or the spouse cannot be an employee, health insurance premiums for the self-employed individual are 100% deductible as an “Adjustment to Income.”  The percentage is 100% for the period 2003 through 2010. This 100% is not subject to having itemizing deductions and excluding 7.5% of their adjusted gross income. (Note: Health insurance premiums withheld from a spouse’s check who works at another employer are not eligible for the 100% self-employed health insurance deduction.)
  5. A Schedule C is filed with the sole proprietor’s personal income tax return. A separate income tax return is not needed.
  6. If the sole proprietor is the only person working in the business, quarterly and annual payroll tax returns are not required.
  7. Business use of home is more easily achieved than under any other type of entity.

Disadvantages of a Sole Proprietorship:

  1. All income is subject to self-employment tax. Calculated as: 12.4% of 92.35% of Gross Income (Not to exceed $87,900 in 2004 and $90,000 in 2005) and 4.9% on the total amount earned. A 50% deduction of the self-employment tax is allowed for regular tax purposes and is not subject to itemizing deductions.
  2. Potential personal liability (no corporate protection).
  3. Too easily confused with your personal matters.
  4. Occasionally not recognized as a “real” business.
  5. If losses are incurred in 3 of 5 years, the U.S. Treasury may consider the business as a “Hobby” and disallow all losses.