What Is a Sole Proprietorship?
A sole proprietorship is the least expensive and easiest way to start operating a business as it already is. You do not need any documents or forms unless you intend to run the company under a different name than yours or your location requires you to have a business license.
As implied by its definition, a sole proprietorship is limited to a single person. Suppose the business owner wants to admit another owner. In that case, even if it is just a spouse, family member, or friend, the sole proprietorship must end. By default or intent, adding another owner will create a new business arrangement, such as a partnership.
Advantages of a Sole Proprietorship
Starting a business can be overwhelming and quite time-consuming. For someone who wants to get a business off the ground and running quickly, a sole proprietorship can be a quick and easy answer. Banking is more straightforward, and there are typically fewer forms and fees required.
A sole proprietor has total control and decision-making power over their business. Without any partners, members, or boards, you are the only business owner and can run it as you please.
Not a Taxable Entity
A sole proprietorship business is not treated as a separate taxable entity. Any business income is reported on Schedule C of the owner’s individual tax return and is only taxed once to the business owner. However, the owner of a sole proprietorship will likely be subject to self-employment (Social Security and Medicare) taxes on all business profits.
Disadvantages of a Sole Proprietorship
Lack of Support
Even though it can be beneficial to have complete control over your business, as the sole proprietor, you are responsible for the successes and failures of the company. This fact can add an extra layer of stress and pressure.
No Liability Limits
The owner is personally liable for any business obligations in a sole proprietorship. As such, creditors of the business are permitted to pursue your personal assets if the business assets are not sufficient to pay your business debts. Additionally, your personal creditors can pursue your business assets to satisfy your personal debts. If your business might frequently face litigation, you can limit your liability with business insurance. You might want to consider a different business form that offers better liability protection, such as an S-corporation, a C-corporation, or a limited liability company (LLC).
Self-Employment Tax Liability
ole proprietors do not have to hassle with withholding and paying employment taxes, but they do have to calculate and pay self-employment tax if they have more than $400 in net earnings during the year. This tax applies to all of the business’s net profits exceeding the $400 threshold. In addition, sole proprietors typically need to make an estimated tax payment quarterly, including income tax and self-employment taxes.
Requirements for a Sole Proprietorship
A sole proprietorship has no general requirements. However, similar to other businesses, you must obtain the necessary licenses and permits as required by your industry, state, and locality. Suppose you want your business to operate under a name other than yours. In that case, you will need to file a fictitious name (assumed name, trade name, or DBA name, short for “doing business as”) with your state. You will also need to ensure that if you make over $400 in one year, you include that income with your income tax filing and complete a Schedule C.
How to Form Your Sole Proprietorship
There is no formal action required to form a sole proprietorship. As the only owner, this status automatically arises from your business activities. In fact, some people may already own one without even knowing it. For example, if you are a freelance graphic designer or marketing consultant, you are already a sole proprietor.
Which Legal Structure Is Best for My Business?
It is entirely possible that you have already technically formed a sole proprietorship without even knowing it. You may want to continue this way, ensuring that you comply with any business license and tax requirements. Alternatively, you might want to consider other types of legal business formations:
One of these structures might better suit your needs, especially if your business is growing or you desire to branch out further. While it may seem confusing, at Steinberg Law, we can help you understand each type of business structure so that you can determine the best fit for your business goals. We can assist you in meeting all legal requirements, no matter the type of formation you select. Reach out to us today to get your business moving in the right direction.