Is a Sole Proprietorship a Legal Entity?
Is a sole proprietorship a legitimate, legal entity? We've been asked that question a number of times. Here's our answer -- and a lot of other information you should know about sole proprietorships.
Is the sole proprietorship a legal entity?
The short answer that question is no–at least not in the sense that it is a separate legal entity like a partnership or corporation. A sole proprietorship is a small business structure that inextricably links the business and the business owner. From a tax and legal standpoint, the two are identical.
Many business owners prefer the sole proprietorship structure because it's the easiest way to launch a new business. While partnerships and corporations require untold amounts of paperwork and legal wrangling, sole proprietorships require little more than appropriate licensing and registration.
Still, the lack of a separate legal identity has certain drawbacks for entrepreneurs. Here are some of the legal and tax considerations to think about when forming a sole proprietorship.
- Tax reporting. Since sole proprietorships are not separate legal entities, they are not separate tax entities, either. As such, income and expenses are reported on the business owner's personal income tax return. This could have some significant tax ramifications, so consult your accountant for advice long before it's time to file your first return.
- Common finances. In sole proprietorships, the distinction between personal assets and business assets is often blurred. It's typical for company funds and personal funds to exist in the same bank account. Similarly, cash flow shortfalls are often funded from personal accounts.
- Financial liability. Partnerships and corporations are separate legal entities that are capable of accruing debts in the same way as individuals. Sole proprietorships, on the other hand, aren't able to borrow capital or accrue debt under their own name. Instead, the business owner is held accountable for the company's debts. If you are a sole proprietor that means your personal assets can be seized to pay business debts.
- Legal liability. One of the most unsettling aspects of a sole proprietorship is that legal liabilities fall squarely on the shoulders of the business owner. Because the company is not a separate legal entity, there is no legal differentiation between the company's legal liabilities and the owner's. Depending on your company's risk profile, legal liability issues could push your firm toward a different business structure.
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