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Sole Proprietorship and Law

What Is a Sole Proprietorship?

A sole proprietor is an individual who owns and operates a business without using a special business entity form, such as a partnership or corporate form. In essence, the person-owner is the business.

When someone starts a new business, they should consider four important factors:

  • ease of organization: what requirements need to be met to start and operate a business?
  • liability: what debts or obligations may they incur in operating the business?
  • tax consequences: how much will they have to pay to the federal, state, and local governments to operate the business?
  • capital: how will they raise the money to operate, invest, or expand?

However, people do not always give a lot of thought to these factors or the structure of a new business that they are forming. This results in them not actually making a choice as to how that business will be organized and operate. Ease of organization, which is the simplicity in meeting the requirements for beginning and operating a business, is an important consideration.

If no serious thought is given to the form of the business and if only one person will be the owner of the business, that person is actually making the choice to operate the business as a sole proprietorship, and in that sense the sole proprietorship is the default form of business organization.

The defining characteristic of a sole proprietorship is that it is unstructured and has only one owner. When someone starts a new business without considering the factors set out above, the usual result is that they start a sole proprietorship.

Formation of a Sole Proprietorship

A sole proprietorship has a single owner, who invests capital into the business. While there is only one owner in a sole proprietorship, a sole proprietorship can have any number of managers and employees.
Even when someone starting a new business considers these factors, that person often selects sole proprietorship primarily because it is so easy to form. Other than a business license and possibly the registration of the name of the sole proprietorship business with the state where the sole proprietorship will do business, nothing more is required to establish a sole proprietorship. If the sole proprietorship business will have employees, then it will need to obtain an Employer Identification Number (EIN) from the IRS, but otherwise, the sole proprietor operates under their Social Security number. No partnership agreements, articles of incorporation, bylaws, articles of organization, or operating agreements are required. As a result of the failure to make a conscious choice of business form or the decision that a sole proprietorship is the easiest way to do business, it is estimated that more than 70% of businesses in the United States are sole proprietorships.

Common Sole Proprietorships

Many types of businesses work well as sole proprietorships. Some of the most common types include knowledge workers, assistants, real estate professionals, and agricultural workers.
A sole proprietorship is a legitimate business form even though it is owned by one person. It is an unincorporated business; that is, the business has not followed the formal requirements of law to legally be recognized as a corporation. This means the business is not a separate legal entity from the person who is the sole proprietor—it has no legal existence independent of the owner of the business. However, a sole proprietor can hire someone to manage the business as long as the sole proprietor is the ultimate decision maker in the business. Also, the sole proprietor can hire as many employees as are needed to operate the business. There is no legal limit to the size that a sole proprietorship business can be, but practically and economically most sole proprietorships are relatively small businesses.

As is true with other business structures, sole proprietorships are governed by the laws of the state where the sole proprietorship business is located. Those laws typically do not require much of the sole proprietor. A business license, which is approval from a local government entity authorizing the operation of a business, will probably be required. Also, if the business will operate under a name other than the sole proprietor's name, state law may require that the sole proprietor register that fictitious name, or adopted name.

Some examples of common sole proprietorships include an accountant who works for clients only during tax season, a master crafter who works alone and whose creations in wood are well-known in the local community, a carpenter who has an assistant and works on relatively small jobs, a freelance writer, and a caterer who hires workers to assist with specific catering jobs.