Definition: A sole proprietorship, often called a sole prop, is a form of business that is owned by a single person and not incorporated. No legal paperwork needs to be filed and no legal requirements need to be met in order to start a sole prop. Basically, as soon as a person starts selling goods or services by himself or herself, he is deemed to be a sole proprietorship.
What Does Sole Proprietorship Mean?
You can think of it as a one-person shop. The owner is the business and the business is the owner. With this simplicity and ease of formation comes some disadvantages. The main disadvantage of a sole proprietorship is the lack of liability protection. Unlike corporations and partnerships, sole props are exposed to unlimited liability. This means that owner can be held liable for all the company actions.
For example, a customer who slipped and fell on the doorstep of a sole prop business could sue the company and also sue the owner personally. The owner could lose his or her house, car, or even savings. Obviously, this is a huge risk sole props have and one of the main reasons why people incorporate. Limited labiality protection is one of the key advantages of corporations.
Sole props aren’t all bad though. Sole prop owners can take advantage of the single taxation structure of the company. Unlike corporations that get taxes on their income and taxes again when the profits are distributed to the owners, a sole proprietorship is only taxed at the individual level. This means the owners only pays taxes on the profits once and can use the money personally tax-free.
Sole proprietorships also have a favorable tax reporting structure. Unlike corporations and partnerships, sole props don’t have to file a separate income tax return. Instead, the company activity is reported on the owner’s personal tax return.