Study: What are sole proprietorships and what are some of its advantages and disadvantages?
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Slide 1 (:15s)
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Welcome to Introduction to Accounting Preparing for a User's Perspective. What are the common forms of business ownership structure in the United States and what are some advantages and disadvantages of each? Sole proprietorships.
Slide 2 (:19s)
Links to an external site. The following discussion will focus on the key characteristics and the advantages and disadvantages of sole proprietorships
Links to an external site.. You should use the Summary of Business Structures table given here to guide you as you learn more about sole proprietorships.
Slide 3 (:34s)
Links to an external site.Sole decision authority: A sole proprietorship
Links to an external site. is a business owned by a single owner that has not been incorporated. Sole means one, or single, and proprietor means someone who owns something. So a “sole proprietorship” would be a business entity that is owned by a single individual, the proprietor. An advantage of a sole proprietorship is that the owner has sole decision-making authority, so for those who want the "final word" on key decisions affecting the business, sole proprietorships are a good bet.
Slide 4 (:47s)
Links to an external site. Easy set-up: Sole proprietorships can be set up very easily. This easy set-up indicates why it is the most numerous structure type in the United States. Each child who has ever set up a lemonade stand by him or herself has effectively created a sole proprietorship. Sole proprietorships are usually small businesses made up of professionals, such as doctors, attorneys or tax accountants, or of small retail stores like a corner grocery store. All you need to start a sole proprietorship is to just start running a business on your own, and voila, you are the 100% owner of a sole proprietorship. Next, we'll learn how to “legalize” a sole proprietorship.
Slide 5 (:17s)
Links to an external site. Minimal regulations: Because many states require businesses that operate in their jurisdictions to pay either state sales taxes or state excise taxes
Links to an external site., most sole proprietorships are required to obtain some type of state tax license.
Slide 6 (:49s)
Links to an external site. State tax licenses can be obtained by completing a registration form and paying a nominal licensing fee. For example, in Hawaii a new sole proprietor need only complete and submit the “State of Hawaii Basic Business Application, Form BB-1
Links to an external site.” and pay a one-time $20 license fee. The whole application and approval process can take less than an hour. The easy set-up for sole proprietorships is a definite advantage of this structure type. The only time any significant regulatory financial paperwork might kick in for a sole proprietorship is when it hires employees and is required to comply with various employment tax and other employment laws.
Slide 7 (:28s)
Links to an external site. Sole proprietorships have no legal requirement to submit financial statements to external parties except to comply with tax reporting laws where the business income of the owner is included in the owner's personal tax return or to comply with contractual agreements. For example, a bank may require a sole proprietorship to provide its financial statements before it will approve a loan.
Slide 8 (1m:09s)
Links to an external site.Single taxation: Many individuals choose to create their businesses as sole proprietorships to avoid what is called "double-taxation
Links to an external site.". Unlike corporations
Links to an external site., sole proprietorships are not separate legal entities and are not directly taxed by state or federal governments. Rather, 100% of a sole proprietorship's income is included on the individual sole proprietor's personal income tax return (i.e. a Form 1040 and Schedule C) and is taxed just one time at the individual's level. On the other hand, the net income earned by corporations is taxed once on the corporate tax return then once again as dividend
Links to an external site. income on the individual shareholder's tax return, resulting in the income being “double-taxed”. As compared to corporations, sole proprietorships have the significant advantage of single taxation.
Slide 9 (:51s)
Links to an external site.Each year the Net Income
Links to an external site. reported by a sole proprietorship will be included on the owner’s personal tax return and will be taxed. Net Income, which is taxable, is not the same as capital distributions to owners of sole proprietorships, because capital distributions are not taxed. Capital distributions are a distribution of the sole proprietorship’s assets to the owner to be used for personal purposes. They reduce the sole proprietorship's assets and reduce the owner’s equity
Links to an external site. in the sole proprietorship. If a sole proprietorship’s net income AND its capital distributions were to be taxed, sole proprietorships would be subject to double-taxation but you already know they only have single taxation.
Slides 10 & 11 (:37s)
Links to an external site.Limited access to expertise: Sole proprietors are often very involved in the day-to-day operational decisions and the accounting for the business. As the business expands, the sole proprietor will often delegate specific managerial duties to employees; however, they will retain the final say on all key business decisions.
One of the disadvantages of sole proprietorships is that because they often run the whole business on their own, they have limited access to the expertise of others like a partnership or corporation might have.
Slide 12 (:22s)
Links to an external site. Limited access to capital
Links to an external site.: Another disadvantage of sole proprietorships is the limitation on their ability to access additional capital. Because their primary access to additional capital is only their own personal resources or what they can borrow from others, they often struggle obtaining the capital they need to expand and grow quickly.
Slide 13 (:36s)
Links to an external site.Unlimited legal liability: Sole proprietors are personally and legally obligated for all agreements, contracts, or loans contracted on behalf of the sole proprietorship. Therefore; the debts of the sole proprietorship are legally debts of the individual owner. This is a major disadvantage and could lead to the owner having to personally sacrifice his/her own personal car, furniture, boat, computer or house, to satisfy the debts of his/her sole proprietorship.
Slides 14 & 15 (:49s)
Links to an external site. Limited life; Difficult transfer of ownership: Sole proprietorships do not exist for extremely long periods of time because they are easily discontinued at the owner's discretion, or they simply cease to exist when the owner passes away.
A sole proprietorship cannot be transferred to someone else. However, the assets and liabilities of a sole proprietorship can be transferred, but they would be transferred into a new business entity and the old sole proprietorship would cease to exist. Because of these factors, sole proprietorships have a life expectancy that tends to be shorter than partnerships and corporations that tend to have lengthy, or indefinite lives, respectively.