What it is:
A sole proprietorship is a person who owns an unincorporated business by himself or herself.
How it works/Example:
Let's say you open a restaurant. If you are the only owner of the business and the business is not incorporated, then your company is probably a sole proprietorship. The status of the company itself is important; if you take on a partner, incorporate, or form an LLC, you are not considered a sole proprietorship.
A sole proprietorship is considered a single entity for tax and liability purposes, and the owner does not pay income tax separately for the company. However, sole proprietors, like other business owners, have specific tax responsibilities regarding payment of self-employment taxes, estimated taxes, social security and Medicare taxes, unemployment taxes, and other taxes.
Why it matters:
In business law, sole proprietorships have unlimited liability, meaning that the owner is personally responsible for the debts and obligations of the business, and lenders may look to the owner's personal assets for payment of these obligations. Limited liability organizations, such as corporations, allow lenders and courts to only seize the assets of the business rather than the assets of the owners. Thus, some business owners may find it more advantageous from a liability standpoint to incorporate or form an LLC.