A sole proprietor is a separate legal entity that is owned by one individual. The owner can be an individual, a partnership, or a corporation.
In general terms, a sole proprietorship is an enterprise consisting of one person who owns it and operates the business under their personal name
Advantages of a Sole Proprietorship
- A sole proprietor can operate a business without requiring any legal or formal process to establish their business; it is automatically created.
- He does not have to register the name of the business entity with any government body and does not need to disclose personal financial information to get credit
- As sole proprietor does not have to disclose personal financial or tax information, liabilities are limited to the business itself. As a result, they are not personally liable for the owner’s individual property
- It is easy to dissolve a sole proprietorship. The business can simply be closed down and the assets liquidated at any time
- A sole proprietorship has more flexibility in reducing or eliminating income taxes than some other forms of businesses that require more formalities like corporations or S corps
Disadvantages of Sole Proprietorship
- With no legal existence of its own, all debts incurred by the business are debts of the owner (the shareholders)
- Creditors may consider only the property held in the name of an individual in the event of bankruptcy. If the business does not have enough property to cover its debts, creditors can go after the owner’s personal assets
- Personal ownership is transferred to heirs when there’s no Will or Testament indicating otherwise. The succession may be problematic if you want your business to continue.
How much does it cost to form a Sole Proprietorship?
The costs of starting a business depend on the type of business (service or product), where it’s located, and whether the business owner will need specialized licenses to start their business.
Ways to investing in Sole Proprietorships
- Starting a sole proprietorship is easy and cheap. All you need is to open a bank account under your name, pay the necessary fees (if any), create business cards, etc
- Many new businesses are launched with little or no capital at all; they often rely on “bootstrapping” – that is, reinvesting business profits into further growth of the company. This may be hard for new companies if they’re not generating enough profit yet
- Many startups fail within mere months of opening their doors for business. In fact, the majority of small businesses do not survive past their first year. Still, those who can surmount these initial obstacles have a chance to build something great from nothing.
- Business loans are available through banks or other lending institutions. A loan can be used to acquire essential equipment, expand the business premises, cover advertising costs, etc. Loans are usually granted after assessing the creditworthiness of the borrower(s).
Types of Business Entities
In the United States, there are several options for businesses to choose from as far as filing a business legally.
- The first is a sole proprietorship which is the simplest form of business and does not have to be registered with any state or federal agency. You can conduct business without requiring any legal formalities other than registering the name of the company. It may also file taxes under its own social security number
- A second option is a partnership which consists of two or more people who enter into a written contract that outlines how they will be splitting business income, responsibilities, etc. It requires no registration with any government agency however it must file an annual tax return (IRS Form 1065) that reports all income earned by both partners during the year
- The third option is starting a corporation. Most states require the corporation to be registered with either Secretary of State or the Department of Commerce. It requires filing Articles of Incorporation with the state, form 2553 with the internal revenue service (IRS), and issue stock certificates. A corporation files its own tax return (IRS Form 1120).
Steps to Form a Sole Proprietorship
Step 1:Pick your Business Name
Your business name should be distinctive because it helps people find you in the marketplace. You are not required to register or have your business name approved by any government agency.
However, even if you haven’t filed for this formal approval it is still a good idea to conduct a search to see if anyone else has already taken the name. If someone has reserved that same name then you will have to choose another one
Step 2: Tax Identification Number/ Employer Identification Number (EIN)
You cannot file any legal documents without an EIN number which is why you need one before opening your business bank account. This number can be obtained by submitting IRS Form SS-4 to the Internal Revenue Service, which is free of charge.
The EIN is used for tax purposes, notifying creditors of your business name, opening a bank account in the name of your business, and filing taxes
Step 4: Fictitious Business Name Statement (Optional)
If you are using a fictitious name to do business, then this statement will have to be filed with the county clerk’s office where you reside or plan to operate full time. Not all states require one but it may help avoid confusion over your legal name which should be unique in the marketplace
You can choose to skip this step if you aren’t planning to open an actual company location
Step 5: Outlining Business Structure and Ownership
You need to determine if you want a partnership or corporate structure before you start a sole proprietorship. If you do decide to form a partnership, you need to choose the partners carefully because the decisions they make today will affect your business for years to come.
Setting up a corporation may cost money but it also offers limited liability protection which is an added benefit. You have complete authority over your business and no one else can run or operate it even if it means that you cannot delegate any such task
Step 6: Business Licenses (Optional)
States require businesses to obtain licenses in order for them to function legally within their jurisdiction. Ensure that you research what’s required in your state and apply for this license immediately after starting your company
Step 7: Company Bank Account
The purpose of this step is pretty much self-explanatory. You will need a business bank account so that you can deposit money earned from your business as well as pay for any supplies needed to operate your business.
This step is not mandatory especially if you only have limited transactions but having a separate account for your company will provide it with much protection and peace of mind
Step 8: Business Insurance (Optional)
Depending on the nature of your company, insurance coverage might be necessary. This includes property insurance, vehicle insurance, equipment insurance, and general liability. The amount you choose to insure should depend on the size of your operation however it doesn’t hurt to err on the side of caution. Allstate has excellent resources to help small businesses find affordable options
Follow these eight steps and you will be on your way to forming a sole proprietorship. However, not every state requires business owners to file certain documents so it is always best to check with your local authorities before starting anything.
Sole proprietor vs. independent contractor
Business owners often find themselves in the conundrum of trying to decide whether to hire an employee or contract an independent contractor. The answer involves weighing many factors, including how much control you want over the work being done, what kind of work is needed, and how long you need it.
When choosing between a sole proprietorship versus hiring an independent contractor there are pros and cons for both. A sole proprietor has no legal existence other than that created by its owner(s). It cannot sue or be sued in its own name
An independent contractor is hired to perform specific duties rather than take on permanent employment status. The relationship between your company and an independent contractor can vary greatly depending upon the nature of their job assignment; its important to understand the risks involved with this choice.
Can I be a self-employed sole proprietor?
In general, a sole proprietor is an unincorporated business owned by one individual who personally owns and manages the business. In other words, there is no legal difference between the business and the owner.
If you are going to be a sole proprietorship in your new business venture, it’s important to understand your responsibilities as they relate to state and federal income taxes
As a sole proprietorship, no formalities are required for filing taxes or reporting financial information
Some of the most common types of businesses that file as a Sole Proprietorship include:
- Self-employed professionals such as consultants, independent agents
- Freelance writers
- Athletic coaches
- Home-based businesses such as consultants, writers, or craft vendors
- Pet sitters
- Mortgage brokers
How is a sole proprietorship different from other business structures?
In general, a sole proprietorship is an unincorporated business owned by one individual who personally owns and manages the business. In other words, there is no legal difference between the business and the owner.
There are some exceptions to this rule:
- Sole proprietors may be limited in how they can run the business
- Sole proprietors cannot raise capital by selling a share of the business to someone else
- A sole proprietor’s personal assets are at risk if there is a lawsuit filed against the business
However, most small business owners will file as a sole proprietorship because it is relatively easy and inexpensive to set up. A simple filing with the state is often all that’s necessary to create a sole proprietorship.
How Do You File Taxes?
In most cases, you should receive a Schedule C from your business accounts. You will use this form to report all revenue and expenses from your sole proprietorship as income or loss on the appropriate lines for federal tax purposes.
Some of the most common deductions include:
- Office expenses such as printer paper and ink cartridges
- Costs associated with self-employment tax (such as Medicare and Social Security)
- Advertising expenses including newspaper ads, internet marketing campaigns, etc
Should I Form an LLC or Sole Proprietorship?
As a sole proprietor, your business can operate in any legal form that you choose. However, only corporations are required to have bylaws.
LLCs are also allowed to have operating agreements which are similar to bylaws for corporations.
However, it is important to keep in mind that there are very few differences between an LLC and a corporation when compared to the operation of a sole proprietorship. What this means is that if you own a business, becoming an LLC or corporation may not provide you with much additional protection against liability claims.
How Do You Convert a Sole Proprietorship to an LLC?
Converting your sole proprietorship to a limited liability company can be a complicated process. In most cases, you will need the assistance of a qualified attorney.
However, it is important to note that if you have already filed an LLC or corporation in another state, this information may not transfer over to your new state
In many cases, converting from an existing structure may cause your tax filings and reporting requirements to change-if you find yourself in this situation, bookkeeping services such as those offered by AccountTitan LLC can help.
In addition, if you do not have an LLC operating agreement, it’s extremely important that one be prepared before filing any paperwork with the Secretary of State office in your home state.
Do I Need a Lawyer to Help Me File Sole Proprietorship Taxes?
The best person to hire for help with your taxes is an accountant.
An accountant can usually provide you with comprehensive tax services such as:
- Assistance with proper business recordkeeping and accounting practices
- Assistance filing your annual returns and any necessary documentation needed to avoid late fees or penalties
- Assistance preparing documents that will need to be filed when making large purchases, selling assets, etc
Accountants typically bill by the hour. You should expect to pay between $50 and $300 per hour depending on the location and experience levels of the accountant. If you find yourself in a situation where you think legal guidance will be necessary, it is important to contact an attorney with experience in business law.
Being a sole proprietor means that you are responsible for any business’s debts or lawsuits that may result, however starting a sole proprietorship is relatively easy and inexpensive.
Making the transition to an LLC or corporation can be complicated; therefore it’s best to consult with accountants and attorneys when making this decision.