There are no federal requirements to establishing a sole proprietorship, and typically no state requirements, either. Some cities or counties may require a license to do business within the locality. While other business entities require officers, a board of directors or annual meetings, the individual proprietor holds complete control. You decide how to run the business, including personnel, advertising and client relationships. You have the right to receive all of the business profits.
The biggest disadvantage to doing business as a sole proprietor is there is no limit to liability. Your personal assets are at risk if the business is sued by a creditor or becomes involved in other litigation. Malpractice insurance is available, but there is no guarantee that you will not face a judgment beyond what your malpractice insurance covers. Another downside is tax liability. All business earnings are taxed directly to the individual at your individual tax rate and subject to self-employment tax. The only way you can transfer interest in a sole proprietorship is through selling assets, which typically incurs additional tax liability.
Access to capital to establish a sole proprietorship may be limited. Lenders may be more prone to offer financial assistance to a registered business entity instead of an individual. Another issue is that when you die, the business dies with you. Family members interested in proceeding with your legacy will have to establish an entirely new entity.
Other business structures offer some liability protection, as well as more beneficial tax consequences. State laws vary on the types of businesses that can be formed within the state. Most states allow a limited liability company, which gives management flexibility similar to a sole proprietorship, as well as liability protection. While an LLC can protect against business debts, it will not shield you from professional negligence. A limited liability partnership, or LLP, is similar to an LLC, except for tax consequences. An LLP may also require that one partner accept additional liability, depending on state law. A professional limited liability company, or PLLC, is an LLC used by licensed professionals. Some states require licensed professionals to form as a PLLC instead of an LLC.