Sole proprietorships get a lot of bad press. A lot of accountants and attorneys like to run down sole proprietorship’s. But I don’t mind sole proprietorships — I operated my business as a sole proprietorship for a long time.
Here are some of the advantages of operating as a sole proprietor:
- They are easy to get into. There’s no real paperwork to fill out. You just start conducting business.
- They are simpler to administer and therefore your accounting and legal fees will generally be lower.
- As your business grows you can always convert to something else. As you go up the ladder from sole proprietor to corporation, it’s easy. But it’s hard to go down the ladder from a corporation to a sole proprietorship.
There are also plenty of disadvantages:
- The self-employment tax is a big hit because that’s 15.3% on top of any income taxes that you will owe.
- You are not considered an employee of your sole proprietorship (except for self-employment tax purposes) so any money that you take out of the business is not deductible as wages.
- Meaning, you are taxed on your net income even if you take no money out of the business. So say you have $50,000 of net income from your proprietorship but you live on savings or you live on your spouse’s income and you take no money out of your sole proprietorship for yourself. It doesn’t matter — you still pay taxes on $50,000. And even if you withdraw all $50,000 for yourself, that withdrawal is not deductible as wages, so you’re still paying tax on $50,000.
- There is no way to split income. That’s a benefit of being a sole proprietorship – you get to keep it all. But it’s also a downside to being a sole proprietorship — you are taxed on all of it.
- The tax treatment of health insurance is also much less “tax friendly” when you are a sole proprietor compared to when you are a rank-and-file employee. A full discussion of health insurance is another discussion for another blog post.