So you’ve made the decision that you want to start your own business. One of the very first decisions you will have to make is to choose what form of organization that you’d like for your business. There are a number of choices with various tax consequences. A Sole Proprietorship is owned and controlled by
Starting a Sole Proprietorship in Minnesota
In a sole proprietorship, the business is not able to own assets because they are considered personal property of the owner of the business. No legal documents are required for this type of business. There are few requirements other than complying with state and local licensing and taxation laws. This includes registering you business with your Department so that your business’s personal property can be properly assessed, and the business can obtain a state or local license.
Although sole proprietorships may be the least difficult business entity to form, even experienced entrepreneurs can encounter difficulties. For help starting a sole proprietorship in Minnesota, contact the Minnesota lawyers of Thompson Hall by calling (612) 466-0010 today.
In a Sole Proprietorship[i], one person owns all of the assets of the business and is solely liable for all of its debts. In short, the Sole Proprietor is the business:
Any person who conducts business without creating a separate organization is operating as a Sole Proprietor.
The Sole Proprietorship is not subject to state rules covering organization or operation. Federal and state income tax regulations apply to the business operations but represent the only formalities of conducting business. No annual reporting requirements other than those made to taxing authorities are expected of the Sole Proprietor.
However, if the name of the business is different from that of the Sole Proprietor, then the law of most states considers the business to be operating under a “fictitious business name” and requires the filing of a Certificate of Assumed Name. Also known as “doing business as,” the Sole Proprietor in this instance is operating her business using a name other than her actual name. The underlying concern is rooted in consumer protection, since the public could be confused in not knowing who they are doing business with and therefore misled.
For example, let’s assume Jane Doe starts a new business called “Real Deer Antlers.” Since her actual name is not contained within her business name, Jane would be considered as doing business under a fictitious name: Jane Doe d/b/a as Real Deer Antlers. Jane is required to make an “assumed name” filing with either the Office of the Secretary of State in which she operates the business or the Office of the County Clerk in which she operates the business. On the other hand, let’s assume that Jane Doe does business as “Jane Doe’s Real Deer Antlers.” Here, she would not be required to make the assumed name filing, since her actual name is contained within the business name.
The absence of state filing fees or the need for formal agreements makes this form of doing business the easiest and least costly of all business organization. It affords the Sole Proprietor great flexibility in formulating and implementing a business plan, since she is in complete control of the business. For those who must be their own boss, the Sole Proprietorship is the legal entity of choice!
The Sole Proprietor pays only a single level of income tax; that is, she reports income and expenses from the business on her personal tax return – IRS Form 1041. Income and expenses are reported on Schedule C, “Profit or (Loss) from Business,” of the owner’s Form 1040, along with Schedule SE, “Self Employment Tax,” if income exceeds $400. Since the Sole Proprietor is taxed at the individual level, her “tax bracket” applies to the business income. She is not subject to taxation at the business level, only the individual level.[ii]
One major disadvantage of doing business as a Sole Proprietor is that every trade debt or liability of the business is the personal responsibility of its owner. This personal responsibility is inherent in the form of the business and is unlimited. So, all of the Sole Proprietor’s personal assets (cash, stocks, bonds, collections, cars, etc.) are subject to the claims of her business creditors or customers. Some may believe that, in our example noted above, Jane Doe doing business as Real Deer Antlers would relieve her from personal liability, but Courts throughout the nation have uniformly ruled that the designation “doing business as” or “d/b/a” is merely descriptive of the person who does business under some other name. Courts have stated that doing business under another name does not create a legal entity distinct from the person operating the business.
These risks are not easily insurable. As a general rule, the Sole Proprietor can probably insure against money damages of successful lawsuits against the business for accident, errors and omissions, and defects in product or workmanship. Insurance coverage may be too costly for many Sole Proprietors or simply too limited in scope to gain any substantial advantage, however. Furthermore, the personal responsibility for trade debt is not an insurable one; that is, the Sole Proprietor cannot insure against the claims of her trade creditors.
Another limiting factor confronting the Sole Proprietor is her inability to raise capital for her business venture. A Sole Proprietor can realistically tap only her personal funds or those of her friends or family members. Occasionally, the Sole Proprietor may qualify for a Small Business Administration loan but the application process is laborious and time intensive. Venture capital is traditionally unavailable to the Sole Proprietor. The risk is substantial in both monetary and personal terms:
“Many entrepreneurs mortgage their homes, raid retirement funds, and use credit cards to finance the initial operations of the business. Access to these sources of capital may be critical to start-up business, but they come at a high emotional and financial cost. … In addition, a company having been funded by family and friends that ultimately fails can be financially catastrophic for the family and friends.”[iii]
Some entrepreneurs, however, move forward in this fashion with incredible results! Michael Dell did exactly this when launching his computer company from his college dorm room with only $1,000 of his own money. Today, his net worth has been estimated at $17 billion, and he is one of the richest men in the world, according to Forbes magazine.[iv]
Finally, the “life” of a Sole Proprietorship is limited in scope. It ends upon either the discontinuation of business or the death of the proprietor. This form of doing business does not allow for any kind of “succession planning” by which the business would continue despite the death of its owner.
The business owner can organize a legal entity in which to conduct business that provides limited liability and therefore alleviate the problem of personal liability. Also, a legal entity provides advantages in insuring risks and raising capital. Some of the more sophisticated forms of doing business remain cost-effective to the owner.
[i] The Sole Proprietorship is the oldest and most common of small business organization in the U.S. today. In 2003, the IRS received 19,710,079 returns from non-farm Sole Proprietorships with profits totaling $230 Billion. See Table 1.–2003, Nonfarm Sole Proprietorships: Business Receipts, Selected Deductions, Payroll, and Net Income, by Industrial Sectors Classified with the North American Industry Classification System, available at http://www.irs.gov/pub/irs-soi/03sp01cs.xls.
[ii] See IRS Publication 334.
[iii] Richard A. Mann, Michael O’Sullivan, Larry Robbins, and Barry S. Roberts, Starting from Scratch: A Lawyer’s Guide To Representing A Start-Up Company, 56 Ark. L. Rev. 773, 821-22 (2004).
[iv] Forbes Magazine’s 2006 list of the richest people in the world is available at http://www.forbes.com/lists/2006/10/WJOB.html.
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Starting a Sole Proprietorship Business in Minnesota
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