It's tempting to cut through the paperwork and avoid such legalistic business structures as limited partnerships. Here are the pros and cons of owning your own business outright, as a sole proprietorship.

by Mark E. Battersby [March 14, 2001]

Among all of the entities that are available to anyone beginning or operating an ISP business, the simplest structure is the sole proprietorship. A sole proprietorship usually involves just one individual who owns and operates the enterprise. In fact, if the ISP business has only one owner, the Internal Revenue Service will automatically assume that it is a sole proprietorship.

From the IRS's perspective, a sole proprietorship is not a taxable creature in itself. Instead, all of the business's assets and liabilities are treated as belonging directly to the business owner. The annual income and expenses generated by the business are reported on Schedule C, Profit Or Loss From A Business, which is part of the business owner's individual tax return (it gets attached to Form 1040).

From the ISP owner's perspective, the tax aspects of sole proprietorships are especially appealing because income and expenses from the business are included on the owner's personal income tax return. This may allow you to deduct business losses suffered by your ISPs from income earned from other sources.

Levying taxes on yourself
The self-employment tax could best be compared to the wage taxes of employed individuals. However, not only must the sole proprietor of an ISP or other business pay the employee's share of those Social Security (old-age, survivor's and disability insurance) and Medicare (hospital insurance) taxes, the sole proprietor is also responsible for the employer's share as well.

To provide for current payment of income taxes not collected through withholding, the law requires sole proprietors to pay a portion of their tax, both income and self-employment taxes, quarterly.

Plus, every sole proprietor is also required to file a Schedule SE, Earnings From Self-Employment, with their Form 1040. Schedule SE is used to calculate how much self-employment tax is owed.

Boons and boondoggles
Naturally, there are a few disadvantages to sole proprietorships. Selecting the sole proprietorship business structure means that you are personally responsible for the operation's liabilities.

Everyone operating as a sole proprietorship is placing all of their personal assets at risk. Those personal assets could be seized to satisfy a business debt or a legal claim filed against the ISP operation.

As mentioned, it is often difficult for anyone operating an ISP as a sole proprietorship to raise money. Banks and other financing sources are often reluctant to make business loans to sole proprietors. Usually, an ISP owner operating a sole proprietorship will have to depend on his or her own financing sources such as savings, home equity, family loans, or plowing the ISP operation's profits back into the business.

The main advantage of a sole proprietorship is simplicity. Because there is only one owner, the accounting rules are much easier to understand and use.

When a sole proprietor pays himself or herself, it is only a matter of withdrawing money from the business checking account—no need to issue a paycheck and make payroll tax deductions.

Similarly, a sole proprietor who decides to contribute personal money to the ISP business, simply adds it to the operation's checking account. No need to formally make—and keep track of—capital contributions as you would with a partnership or a corporation.

Conjugal proprietors
The question of a husband and wife operating a business frequently arises. Although a husband and wife can—and frequently do—jointly operate an ISP business and even file joint income tax returns on which the income or losses of a sole proprietorship are reported as joint income, the self-employment tax rules do not accept "plural" owners of self-employment income.

Under these rules, self-employment income is attributable to only one spouse: the one who exercises a substantial portion of management and control over the business. Naturally, it may be advantageous for each spouse to carve out a piece of the ISP business for themselves. This is especially desirable if each spouse wants to separately build up their contribution base in the Social Security system. To accomplish this, there must be two, side-by-side (husband and wife), sole proprietorship (self-employed) businesses. Additional complexity, but legal.

Your dream may have always been to be the sole proprietor of your ISP business, but it's not always in your best interest at tax time to be the ship, captain, and crew of your operation.

Of course, as you'll see next week, there may be other business entities better suited to husband and wives operating an ISP or related business.

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