Terminology Overview:

Sole Proprietorships

The sole proprietorship is the simplest form of business entity. Legally speaking, an owner of a proprietorship is inseparable from his company. There may only be one owner at a time of a sole proprietor business. Business profits and loses are passed through to be reported on the owner's personal tax form, Form 1040, Schedule C. A disadvantage of sole proprietorships is that the owner has unlimited personal liability when it comes to the business.

Ownership of your business can be shared with your spouse and will still maintain the status as a sole proprietorship. However, in the eyes of the IRS, your spouse will be viewed a co-sole proprietor. In this case, you can choose to split the profits of the business if you file separate returns or you can report all of them on your joint Schedule C. Only spouses qualify to be a co-sole proprietor. When joining with any other member of your family, the business must be organized as a partnership, limited liability company, C corporation or S corporation.

Tax sheltered retirement plans, such as a Keogh plan, are available for owners of sole proprietorships. Therefore, as far as retirement plans go, a sole proprietorship is equal with a corporation. However, the sole proprietorship lags when it comes to medical expenses in comparison to a corporation. This is because a sole proprietor can only deduct up to 40% of his family's health insurance premiums on the Form 1040. The remaining 60% can be deducted as an itemized deduction on Schedule C, but only to the extent that the 60% of the premiums exceed 7.5% of your adjusted gross income for the year. In a corporation, if you hire yourself as an employee, the corporation can pay for 100% of your family's health insurance premiums and uncovered medical expenses and then take these amounts as a business deduction.

Following are some more pros and cons that come with operating a sole proprietorship:

  • Should you decide to take on a partner at some point, you will need to reorganize the business as a partnership or corporation in order to be able to take on additional owners.
  • Upon the death of an owner, legally, the proprietorship ceases to exist.
  • Sole proprietorships must use the calendar year for accounting purposes but may use either the cash or accrual method of accounting.
  • Converting to a C or S corporation can usually be done relatively painlessly at little cost and no or minimal tax consequences.