This is the most basic form of doing business. As one tax analyst puts it, “You keep all the profits and accept the entire risk of loss. It is capitalism at its most basic.” Sole Proprietorship is best for very small businesses and in early start-up phase.
No formal action need be taken; you merely start doing business. However, the municipality or state in which one resides might require various licenses, depending on the nature of the business and where it’s being operated.
You report business profits or losses on an individual tax return. On Schedule C, you list business income and take deductions for expenses. The net profit is taxed at personal income tax rates (federal rates range from 15 to 39.6 percent). If you lose money, you cannot deduct losses but can carry them forward to the next tax year. Should you make a profit that next year, you deduct the losses accrued from the previous year (or years) from your profit. However, you cannot reduce your net business income to less than zero.
You are personally liable for every business debt, just as if you had incurred such liabilities as personal expenses. That means all of your personal and business assets are at risk.
Most banks and other lending entities will require personal collateral (home equity or other valuables). Too often, capital is generated only from your personal resources—by borrowing on credit cards or from family.
You have no separately existing business entity. Thus, if you die or become incapacitated, your business goes with you. Selling is a bit more feasible—but only if you have an established service business or a readily assumed, product-based business. For these reasons, estate planning becomes vital for sole proprietors.