This description is general, and will vary based on state law.
A sole proprietorship is an unincorporated business comprised of one individual. In a sole proprietorship, a proprietor (owner) has unlimited personal liability for all the debts, actions, and operations of the business. The owner makes all the important decisions and is responsible for the operating results of the business. The business and owner are the same for all practical purposes.
A sole proprietorship is not a taxable entity separate from the individual who owns the business—it is taxed at the individual rate. All business income from a proprietorship is reported to IRS by the owner on Schedule C (Form 1040), Profit or Loss from Business or Schedule F (Form 1040), Profit or Loss from Farming. These forms are essentially an income statement for the business for the year.
Sole proprietorship tax returns may be prepared on a cash basis. Cash basis tax accounting does not produce a balance sheet. It is sound practice in loan underwriting to obtain business balance sheets (when possible) and income statements for a reasonable period sufficient to determine the financial trend through analysis of the business. If a balance sheet is not available, a credit union should perform reasonable due diligence to understand the borrower’s current assets and liabilities and ensure the borrower is current with other obligations.
A credit union should determine if a borrower is current with accounts payable obligations, and should also review tax return reports (which list all sources of income) to make appropriate adjustments in the credit assessment.
Documentation
The documentation available to substantiate a sole proprietorship is usually limited to an assumed name certificate or other registration with the Secretary of State where the business is registered, which indicates a proprietor is “doing business as” the trade name of the entity. Legal documents will be styled in the individual sole proprietor’s name and the trade name, if applicable.
Last updated November 25, 2016