The simplest and most common form of business entity is the sole proprietorship. It is the easiest to set up, as there are no outside owners or investors. Unlike a corporate structure, there is no requirement for corporate officers or a board of directors, and there is less paperwork.
The business is run by an individual, although it may use a trade name. A sole proprietor can hire employees. In fact, one of the employees could be the proprietor's husband or wife.
There are no outside owners or investors. There is no potential to expand through bringing in additional owners or their capital.
A drawback to a sole proprietorship is that the owner is personally liable for every activity and all debt incurred by the business.
Another possible concern is that if the owner is ill, disabled or dies, the business is not structured for a backup manager to keep the business running. A sole proprietorship ends when the owner dies, so there may be complications with estate planning.
Tax Aspects of a Sole Proprietorship
A sole proprietorship structure avoids the potential for double taxation that may occur with a corporation.
Taxes are paid on an individual's 1040, Schedule C (Profit or Loss from a Business, Sole Proprietorship) and Schedule F if farming is involved. As a sole proprietor, the IRS does not consider you an employee, and you must pay the full amount of Social Security and Medicare taxes, currently 15.3 percent, which is calculated on Schedule SE.
An important difference between a corporation and a nonincorporated business is the tax treatment of medical expenses for the owner and his or her family. A sole proprietor can deduct 40 percent of health insurance premiums on Form 1040. The remaining 60 percent of the premiums and other uncovered medical expenses are deductible only if they are more than 7.5 percent of adjusted gross income. A corporation can pay for all insurance premiums and uncovered medical expenses and deduct the costs as a business deduction.
What can I do about retirement plans?
A nonincorporated business can take advantage of several tax-sheltered retirement programs.
A Keogh plan permits a sole proprietor to put aside 25 percent of after-tax income, up to $30,000 per year. Under a Keogh plan, employees must be covered at the same percentage rate, and the employer makes the contribution. Deferred vesting is allowed, so employees can be required to work up to 3 years before they are covered.
What other retirement possibilities are there for a non-incorporated business?
Another option is a Savings Incentive Match Plan for Employees (SIMPLE plan). As an individual, the sole proprietor can also participate in a traditional Individual Retirement Account or a Roth IRA.