A sole proprietor is an individual that goes into business for himself, and does not have any partners. Any type of business can be operated as a sole proprietorship, and independent contractors and statutory employees are considered sole proprietors. There are no legal issues involved in becoming a sole proprietor, other than the appropriate licensing for your area and profession, and registering a trade name if applicable. Other than that, you just begin operating your business. A sole proprietor can operate under his social security number, but can acquire a federal employer identification number if he chooses to do so. One disadvantage of operating as a sole proprietor rather than some of the other business entity choices is that you are personally liable for all of the debts that your business incurs.
Sole proprietors report their income and expenses on Schedule C, Profit or Loss From Business, or Schedule C-EZ, Net Profit From Business. The total revenue for the business is reported, and then all the expenses of the business are listed and deducted. The net income or loss from the business is then carried over to the Form 1040 as business income. The sole proprietor would be liable for self-employment tax on this business income. The self-employment tax is figured on Schedule SE, and carried over to Form 1040. A credit for one-half of the self-employment tax is taken in the adjustments to income section to arrive at adjusted gross income on the Form 1040.
If your Schedule C ends with a business loss, this is carried over to the income section of Form 1040, and deducted from any other income you are reporting. There are restrictions on the amount of loss that can be claimed if the business is considered a passive activity to you. These are called passive loss restrictions. As long as you can prove that you regularly and materially participate in the business, you are not subject to the passive loss limitations.
There are both benefits and drawbacks to operating your business as a sole proprietor. On the one hand, it is easy to get started in business with no outlay of expense, and you are in total control of the business operations. On the other hand, though, your personal assets are on the line when the business incurs any debts, since you are personally liable for the debts of your business.
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