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What is a sole proprietorship?

A sole proprietorship is one of the simplest businesses to start and manage.

If you want to start a business and run it entirely on your own, you may be interested in a sole proprietorship. These businesses are known for being generally easy to form but don’t offer liability protection.

If you’re in the early stages of starting a new business, you’re likely weighing each business structure to determine which type best meets your needs, lifestyle and risk tolerance. We’ll go over how a sole proprietorship works and the perks and drawbacks of this type of business.

What is a sole proprietor and how does it work?

A sole proprietorship is an unregistered and unincorporated business managed entirely by one individual who is entitled to all the company’s profits. But unlike a single-member limited liability company (LLC), a sole proprietor is responsible for all the company’s liabilities. If a firm goes under, creditors can go after the sole proprietor’s assets.

Advantages of a sole proprietorship

There are many benefits to starting a sole proprietorship. Here are some examples.

  • Management. Unlike other types of businesses, there isn’t as much paperwork to file to start and run a sole proprietorship. In some cases, you don’t need to file any paperwork at all.
  • Control. You own the sole proprietorship and can run it as you see fit while keeping all the profits.
  • Simple taxes. The tax process is much simpler for a sole proprietorship since you don’t have to obtain an Employer Identification Number (EIN) or follow strict business tax guidelines. Instead, you can use your own Social Security number to pay taxes rather than an EIN.
  • Simple banking. You don’t have to have a separate business checking account, as other business structures require. All your finances can simply run through your personal bank account.

Disadvantages of a sole proprietorship

While sole proprietors come with some advantages in simplicity, it also holds its fair share of disadvantages:

  • Liability. As the owner of a sole proprietorship, you are liable for all of the business’s debts. And creditors can attempt to acquire your assets if you cannot meet your liabilities.
  • No legal protection. As the sole owner of the business, you’re personally responsible for any liabilities or lawsuits. For instance, your product may get recalled for exposing customers to potential danger. Or someone may get injured at your physical location and decide to sue.
  • Financing. A sole proprietorship isn’t a corporation, so it’s not eligible for government funding and investors may be hesitant to contribute to its growth. It also may be more difficult to secure business loans from banks and credit unions.

How is a sole proprietorship formed?

A sole proprietorship is generally easy to form. Here is a checklist.

  1. Get a business license. Depending on your type of business and the jurisdiction you operate in, you may need to apply for various business licenses and permits to legally operate.
  2. Register as a DBA. If you are doing business under an assumed name or one that’s not your own, you’d need to register as a DBA with the county clerk.
  3. Get an EIN. If you plan to hire employees, you need to register for an Employee Identification Number (EIN) through the IRS. Like a Social Security number, an EIN identifies your business for tax purposes.

What is required to form a sole proprietor

Once you start working for a business you own and run, you’re a sole proprietor. But you may need some paperwork that varies depending on your type of business, the state you’ll be doing business in, and other variables. And you’d need certain tax forms.

Here is a list of some common documents you may need.

  • Business license
  • EIN
  • Federal Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)
  • Schedule SE for self-employment tax
  • Form 941 for quarterly filing of FICA (Social Security and Medicare) and withholding taxes)
  • Form 1099 for contract employees and subcontractors

Sole proprietorship vs. LLC

A sole proprietorship is different from an LLC, another common type of business structure.

Sole proprietorshipLLC
EstablishmentMinimal paperworkArticles of organization and various documents that vary by state
LiabilityOwners takes on full liabilityMembers are protected from liability over company’s debts
TaxationIndividual tax return for all your profitsProfits “pass through” to members and are taxed as their personal income.

How much does a sole proprietorship cost?

There are technically no costs to start a sole proprietorship. Once you start working for yourself, you’re already a sole proprietorship. But that doesn’t mean you won’t have indirect costs like taxes, licenses and other filing fees.

How is a sole proprietorship taxed?

A sole proprietorship is taxed on all the business’s profits as if it were their own income. You need to submit to the IRS your personal 1040 income tax return come tax time. You also need to submit a Schedule C report, which outlines your profits and losses. In addition, you need to send your Schedule SE for self-employment taxes.

What is sole proprietor business insurance?

Sole proprietor business insurance can help you cover claims against you based on your business. For instance, it can help cover claims for injuries that took place at your business, loss of income due to damage to your business location, loss of income due to data breaches or various types of lawsuits.

Bottom line

A sole proprietorship means you run your own business entirely owned by you and you keep all the profits. But you’ll also be taxed on all those profits personally and you may have other important tax matters to consider. You’d also be solely responsible for any debts and any type of lawsuit your business may face. You should weigh the pros and cons of sole proprietorships and explore other business structures, such as LLCs.

Frequently asked questions

How many employees can a sole proprietorship have?

A sole proprietorship can have as many employees as desired, but it may complicate tax requirements and other matters.

What can a sole proprietorship write off on taxes?

A sole proprietorship can claim several deductions, such as health insurance and equipment expenses. If you work from home, you can claim a home office deduction. Speak with a professional tax advisor to ensure your taxes are filed correctly.

Can I transition from a sole proprietorship to an LLC?

Yes. You’d need to fill out articles of organization through the corporate filing office or Secretary of State and various other forms and documents that vary by state.

Is being a sole proprietorship the same as being self-employed?

Sole proprietors generally work for their own business, and self-employed individuals usually work under a contract for another company they don’t own.

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