Written by:
Christine Hwong

For Entrepreneurs: Forming a Sole Proprietorship

Regardless of company size, it is imperative to decide on the best legal structure of your new company. The legal entity chosen will affect extent of personal liability, taxes and record documentation. Your business structure can take one of five basic forms: the sole proprietorship, the partnership, the regular or C corporation, the S corporation, or the limited liability company.

The majority of the small businesses start off as sole proprietorships, which are the simplest and least expensive option. With a sole proprietorship, the owner and the business are considered one and the same. You have complete control over the business, you make decisions as you see fit and the profits from the business flow through to your personal tax return as Schedule C income. To launch a sole proprietorship, there is no need to file legal paperwork, but you might have to obtain a business license, depending on state law. A sole proprietorship can only be used by an individual who owns the company, unless it is a marital team, in which case it can be shared.

The main downside is that a sole proprietorship assumes unlimited personal liability for all debts related to the business. This liability may make it difficult to attract investors or raise funds for your business. As a sole proprietor, you will assume full burden of Social Security and Medicare taxes. This cost is normally shared between the employer and employee. For 2010, the first $106,800 of self-employment income is taxed at 12.4% for Social Security and 2.9% for Medicare. Any amount over $106,800 continues to be taxed at 2.9% for Medicare only.

Although Sole Proprietorship is seen as an inexpensive alternative to other legal entities, there are significant downsides. Assuming complete personal liability over a risky start-up business is not a wise; however, entrepreneurs in the US have the protection of Chapter 7 bankruptcy. With significant legal fees and 10 years of no credit in bankruptcy, much consideration must be taken prior to deciding the best legal structure for your firm.

Check this out for more information. Photo courtesy of Flickr.