A sole proprietorship is a business operated by one individual, often under the person's own name. This is a common and popular legal structure for small business owners because it is simple to start. You can begin a sole proprietorship without any formal documentation or state filings. The major disadvantage of a sole proprietorship is personal liability – a sole proprietor's personal assets are not protected from debts or lawsuits arising from the company's operations.
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Sole Proprietors and Personal Liability
When a sole proprietorship is sued, the owner is personally named as a defendant in the lawsuit. Corporations and limited liability companies don't expose owners to this risk because they're treated as separate legal entities; this is why the owners of corporations and LLCs are not usually named in company lawsuits, and their personal assets aren't at risk. Some exceptions to this rule apply. For example, if the owner of a corporation commits fraud while engaging in company business, he may expose himself to personal liability.
Judgments and Sole Proprietors
A judgment is a court order that compels a defendant to pay money in a lawsuit. If a sole proprietor refuses or is unable to pay a judgment, the court can authorize a sheriff to seize the defendant's business and personal property. The court can also issue garnishments to freeze business and personal bank accounts and other assets. The resulting money is then paid to the judgment holder if no objections are filed in court within the time prescribed by state law.
Personal Credit and Income
The income and debts of a sole proprietorship are legally regarded as the owner's personal income and debts. Therefore, it is important for a sole proprietor to pay business debts on time to avoid adverse effects on personal credit scores. A sole proprietor's business income is reported on Schedule C of his Form 1040 personal tax return. This differs from a corporation or LLC, which files business income tax returns.
DBAs and Sole Proprietorships
A sole proprietorship is often operated under a fictitious business name or DBA (short for "doing business as") rather than the owner's personal name. The owner must register the DBA in accordance with applicable state law. A DBA does not protect a sole proprietor from personal liability; both the business operating under its fictitious name and the owner may be sued for damages arising from the company's products, services or other liabilities.