Are you thinking about opening your own business?
One common business structure in the United States is the sole proprietorship. As an individual who likely wants to get their business up and running, a sole proprietorship might be an excellent choice for you. This business structure is easy to create and easy to operate.
If you are thinking about a sole proprietorship but aren’t sure what it’s all about, read on to find out all the details you need to know before you open your business.
What is a Sole Proprietorship?
A sole proprietorship is the simplest type of business organization in the United States. A sole proprietorship is just one person, and there is no distinction between the business and the individual that owns it. In other words, the owner is the business.
A sole proprietorship can be thought of as distinct from other business structures, such as LLCs, partnerships, and corporations, because of its relatively informal nature. Although there may be certain legal requirements specific to the type of business you want to run, a sole proprietorship is the easiest to form. Usually, the only absolute necessity for a sole proprietorship is to register for a local tax certificate. Depending on your business, you may also need to take additional steps, discussed below.
Who Can Open One?
The best part about a sole proprietorship is that any adult can form one. You don’t need to meet any specific eligibility requirements. If you’re an individual who would like to start a business, you may do so as a sole proprietor.
7 Steps of Opening a Sole Proprietorship
There are generally no formal requirements for opening a sole proprietorship. In other words, you won’t have any documents to file with your state. Other business structures, like LLCs or corporations, need to submit Articles. Sole proprietorships don’t have any such requirements. Depending on how you wish to run your business, however, there are other legal elements to consider:
- A tax certificate
Most local governments, such as cities or counties, require companies in their jurisdiction to register with the tax collector. This is so that the local government can tax your business. You’ll most likely be able to apply for such registration at your local tax collector’s office. Usually, the process will be called tax registration or tax certification, but it may go by other names depending on where you live. It’s a good idea to contact your tax collector to make sure you’re doing things correctly.
- An EIN
A federal employer identification number, or EIN, is not strictly required for a sole proprietorship. It is necessary if you plan to have employees, however. No matter, it is still a good idea for all sole proprietorships to apply for an EIN. This is so that you can use your EIN to identify your business on relevant documents and accounts, instead of using your own social security number. You can apply for your EIN at IRS.gov.
- A fictitious business name
If you plan to use a made-up business name, you need to register it with your county or state. If you plan to use a business name with your legal name, you won’t need a separate registration. The best way to figure out how this works in your county or state is to contact your clerk’s office.
- A separate bank account
Although not strictly necessary for a sole proprietorship, it’s a good idea to have a separate business bank account. When you do so, you can more easily keep track of your income and expenses, rather than commingling your business bank account with your personal accounts.
- Business insurance
Business insurance is also not strictly necessary, but it’s a good idea to have. You can get general liability coverage for your small business. Depending on the type of business you are running, you may be able to get additional comprehensive coverage to protect you.
- A seller’s permit
If you plan to sell goods to consumers, you’ll need a seller’s permit. A seller’s permit tells the state that you are selling products and allows you to collect sales tax from your consumers, which you then deliver to the state. The process of obtaining a seller’s permit is different across the different states. You may need to check your Comptroller’s office, tax collector, or Department of Revenue.
- Other permits and licenses
Depending on what type of business you operate, you may be subject to requirements for additional licenses and permits. For example, if you plan to have a physical office, you’ll need to check zoning regulations. If you’re operating a business that requires a license, you’ll also need to take care of that separately.
Would I Need a Business License?
As discussed above, you don’t need a separate business license to open a sole proprietorship. In other words, you won’t need to register your business with the state to form it. However, you will likely need to register for taxes, and if you plan to have a fictitious business name. You also need to ensure that the type of business you are running meets all legal requirements.
How Are Taxes Handled?
Taxes in a sole proprietorship are “passed through” to you. This means that you’ll report all business income and losses on your own personal taxes.
Many business owners enjoy this aspect of a sole proprietorship because it makes filing taxes extremely simple. Although it’s still a good idea to keep your business and personal accounts separate, you won’t need to pay taxes on your business and then on your personal income; it will be one and the same. Get more info on how to file taxes as sole proprietor in this article.
What Are the Advantages?
A sole proprietorship has many advantages, making it an ideal business structure for individuals just starting out.
- Easy to get going
One of the main advantages of a sole proprietorship is how easy it is to get your business up and running. Because there are no legal requirements for formation, once you register for a local tax certificate, you should be ready to go.
- No one to answer to
Many individuals like to start sole proprietorships, instead of other business structures like LLCs with multiple members or partnerships. The reason for this is because, in a sole proprietorship, you have no one to answer to. You can make all the decisions for the business yourself and set your own work schedule. You can develop your own personal relationships with clients or customers.For people who don’t like to answer to others, a sole proprietorship can’t be beat.
- Ease of taxes and accounting
Because taxes are passed through in a sole proprietorship, this makes paying taxes extremely simple. You don’t have to file a separate return for your business. Instead, you’ll report all your income and losses on your personal taxes.
This also makes accounting much easier than other business forms. It is ideal to open a separate bank account for your sole proprietorship and to keep track of the business funds coming in and out. Other than that, however, there are no distinct accounting requirements for your business.
- Business losses are deductible
If you experience business losses, especially in the first few years, these are fully deductible on your taxes. You may even be able to deduct things such as a portion of your household expenses if you operate your business from home. An experienced accountant and tax advisor will be able to help you get the most out of your deductions.
What Are the Disadvantages?
Although a sole proprietorship does have a lot of advantages, it also comes with its own set of disadvantages.
- Personal liability
The main downfall of a sole proprietorship is that you have personal liability. If a customer or client decides to sue the business for any reason, your personal assets can be at risk.
- Your reputation is on the line
Since it is only you, any business failings may be detrimental to your future growth.
- Personal responsibility for debts and obligations
In your sole proprietorship, you are exclusively liable for the debts and obligations of the business. If the business doesn’t end up doing well, and you lose money over several years, you are personally responsible for that money. In other words, debt collectors can come after things that you own, and funds in your personal bank account, that have nothing to do with the business.
- Difficulty raising capital
Because sole proprietorships are seen as less legitimate than other organized business structures, you may have a hard time raising capital. From an investor’s perspective, giving money to a sole proprietorship is just like giving money to an individual. Therefore, they may be less likely to part with their funds if they don’t view your business as professional enough.
- Less likely to win contracts
Similarly, if you are in the type of business where you need to chase large corporate or government contracts, this may be more difficult with a sole proprietorship. Since the sole proprietorship is just one person, those large corporations or the government may be concerned about your relationship looking like an employee relationship instead of an independent contractor.
- Business income must be reported as personal income
The tax situation for a sole proprietorship can be an advantage as well as a disadvantage. If you are the business and the business is you, all of the business income that you make in a given year must be reported on your income in that specific year. With other business structures, there are different ways to manage owner salaries and payouts.
- Working constantly
Because you won’t have any partners to help you, you may feel that you are constantly working for your business. In fact, you likely will be working a lot of the time. A sole proprietorship makes it much more challenging to take sick days, vacations, or general time off when you need it.
- Hard to sell the business
It’s hard to sell a company that has no formal business structure. Unlike a corporation, where stocks can be sold, the sole proprietorship is just you. If you would like to try to make any money off your business when you no longer wish to run it, this may prove challenging.
Examples of Sole Proprietorships
Any individual-run small business can be operated as a sole proprietorship. For example, many dog walkers operate their businesses as sole proprietorships. Another great example is hairdressers. Even some professionals, like doctors and lawyers, may use the sole proprietorship structure.
Is This the Right Business Structure for Me?
A sole proprietorship can be a great business structure for someone just starting out. It has a lot of wonderful advantages for an individual.
It’s always a good idea to speak with an attorney licensed in your state for any specific questions you may have. Other than that, congratulations on your new business!