Choice of Entity for Sole Business Owners

What if you're not only a small business owner, but also the only owner of your business? Maybe you’re currently operating as a sole proprietorship, but for one reason or another, you got the idea that you should form a business entity. How do you choose one? What are the advantages and disadvantages of each one? In this three-part miniseries, I’ll take you on a whirlwind tour of (Massachusetts) business entity options for sole business owners. We'll be talking about Sole Proprietorships, Corporations, and Limited Liability Companies.

Choice of entity is a major decision with certain legal, financial, and tax consequences, so it shouldn’t be taken lightly. Which entity is right for you is a business decision depending on a variety of factors, but I’d wager that the most significant ones are typically

  1. Ownership
  2. Liability protection
  3. Tax implications
  4. Costs
  5. Ease of formation

Your preferences with respect to each of these issues will likely strongly influence which entity you select. Now, without further ado, let’s dive in.

Sole Proprietorship

The Sole Proprietorship is the default business designation. It isn’t actually a business entity at all: it’s just you, you are the company. For better or for worse, there are no layers between you and your business. The big advantage of the sole proprietorship is that it’s cheap and easy to form. There are no registration requirements – if you’re doing business for yourself and haven’t formed an entity, you’re already a sole proprietor. You don’t need to file a separate tax return: you report your business income on Schedule C of your personal Form 1040. You can still hire employees. “Sole proprietor” doesn’t mean one-man or one-woman business, it simply means that you’re the sole owner.

The only filing requirement is that, depending on your business name, you may have to register a DBA (“Doing Business As”) with the city or county in which you do business. If you use a name other than your legal name, also known as a “fictitious name,” you need to register your fictitious name in each city or county in which you maintain a location.

For example: if a physician named Shanika Thomas wanted to open a primary care clinic called the “Thomas Healthcare Center,” with her main office in Newburyport and a second location in Boston, she would need to register DBAs with both Newburyport/Essex County and with the City of Boston. However, if Dr. Thomas was operating her clinics under the name “Shanika Thomas, M.D.,” she wouldn’t need to register any DBAs.

Additionally, some banks may wish to see a city/county business registration certificate in order to open a business bank account.

The major disadvantage of a sole proprietorship is that, because the owner is legally the business, there’s no liability protection. This means that the sole proprietor is personally responsible for the debts and liabilities of the business.

For example: if Dr. Thomas defaulted on a small business loan she borrowed to lease the clinic spaces, she would be personally liable for the debt.

Another disadvantage is that expansion is somewhat limited. You can certainly grow your company, hire more employees, and open additional locations, but you can’t take on partners or co-owners. Moreover, the business terminates upon the death of the sole proprietor. That said, depending on the nature of your business, a sole proprietorship might be a good option. I think that the sole proprietorship can be a particularly good option for licensed professionals because, as I’ll discuss further in the post covering Corporations, the liability protection afforded by a corporation or limited liability company does not cover professional liability. If you’re a licensed professional with no employees, a mainly virtual/online practice, and you already carry professional liability insurance, a sole proprietorship might be a reasonable option.

In sum:

  • + Little to no filing requirements
  • + No filing fees or annual fees
  • + Taxed as an individual
  • + May hire employees
  • - No limited liability protection
  • - No co-ownership
  • - Doesn’t survive owner

In my next post, we'll discuss Corporations! 

As always, if you have any questions, don't hesitate to contact me!