5 Reasons to Setup Shop as a Sole Proprietorship

Small business owners and entrepreneurs regularly agonize over the incorporation question--and about related topics such as when a limited liability company makes sense and when does an S corporation really save an owner taxes.

This obsessing over more sophisticated (and expensive!) entity options is too bad, however. New small business owners can count at least five great reasons to start a small business as a sole proprietorship.

Reason 1: Simple Setup

As compared to incorporating or forming a limited liability company, sole proprietorships are a breeze. All you really need to do is start. That's it.

Note: State and local governments usually want you to get a business license so they can begin taxing your new business. But getting a business license in many cases is pretty easy. Check the phone book or call your local state or municipal government offices.

Reason 2: Easier Accounting

If you run your business as a sole proprietorship, you keep your accounting truly easy. If you're the only worker, you won't even have to do payroll. Not having to do payroll saves tons of time, lots of money, and means you avoid doing between five and ten payroll tax returns a year: quarterly federal and state returns, the annual federal unemployment tax return, W-2s, and so forth.

What's more, you won't have to prepare balance sheets as part of your business tax return. Your sole proprietorship's income and deductions will typically be reported inside your individual tax return on a single page of paper.

In comparison, corporations and partnerships often do have to prepare balance sheets for their tax returns and a boatload of other supporting schedules. Commonly a corporate tax return runs between ten and twenty pages in length. Yikes.

Reason 3: Minor Children as Tax Shelters

If you employ your minor children in your business, a sole proprietorship offers up one of the sweetest small business shelters there is. Wages you pay your teenage kids count as business tax deductions--which saves you income taxes and self-employment taxes. But the amounts your minor children earn probably aren't taxable to them for either income tax or Social Security and Medicare taxes purposes if they make less than the standard deduction amount.

Note: The standard deduction amount equals $5450 in 2008. In the years after 2008, the standard deduction increases because of inflation.

The ability to employ minor children, take the tax deduction on your tax return, and then let the kids avoid income and payroll taxes could save your family almost $3,000 in taxes per year per kid working in the family business. Wow.

A final caution: The children need to be doing real work for a realistic salary.

Reason 4: Easy Deductibility of Health Insurance

Sole proprietors can more easily take a deduction for family health insurance. The rules are a wee bit tricky. The family can't be benefiting from subsidized health insurance from, say, a previous employer (like the military) or the spouse's current employer. And you get the medical insurance deduction only to the extent your business makes money.