Often thought of as the easiest business structure to set up, a sole proprietorship is indeed one type of business that you can start in a weekend. We’ll touch on the pros and cons of a sole proprietorship, as well as how to start one so you can go into business. Let’s dive right into it and start off with the basics.
What Is a Sole Proprietorship?
A sole proprietorship is a type of business structure where an individual, known as the sole proprietor, owns and operates a business on their own. It is the simplest and most common form of business ownership. Think of an individual who is selling goods at a farmers market on the weekend, a hairdresser or an ice cream truck. While these all could be registered as LLCs, we’ll focus on them as sole proprietors.
In a sole proprietorship, there is no legal distinction between the business and the owner. This means there can be big risk, something we will touch on in just a comment.
What are the Pros of a Sole Proprietorship?
Sole proprietors’ pros/benefits are often the driving reasons that people love the business structure.
- You don’t need to register with the state although you do need permits and licenses to operate in the jurisdiction.
- Taxes are simple as they pass through to Schedule C of Form 1040.
- The lifespan of the business is tied to the owner’s lifespan.
- You don’t need a bunch of legal documents to get started.
- The cost to start them up is minimal.
If you are thinking you want to start an online business this weekend, be an author or sell crafts, you can. Just be sure to check if you need local licenses. Although there are tons of pros to a sole proprietorship, there are also some drawbacks.
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What are the Cons of a Sole Proprietorship?
The cons of a sole proprietorship are what some people see as pros. Having the business tied to an owner’s lifespan means it can’t operate into perpetuity. Minimal legal documents might not be the best when you want an organized structure to fall back on.
There is one big red flag though. It is the liability of the sole proprietor. The assets of the sole proprietor are not separated from the business. This means that if your business gets into financial distress or is sued then there is no protection between your personal assets and the business. Everything is generally fair game for a creditor if you have guaranteed debt with your personal assets to the business.
Does that stop people from starting their businesses as a sole proprietor? Absolutely not. The sole proprietor structure is a great way to get up and running fast but due to some of the cons, some businesses decide to incorporate down the line.
How Do You Set up a Sole Proprietorship?
We said it was fast to set up as a sole proprietor and we meant it.
First, you’d start by choosing a unique name for your business that is not already in use by another entity in your jurisdiction. It is a good idea to research trademarks and domain names to ensure availability. State websites often have a doing business as (“DBA”) search function as well.
Often you don’t need to register your sole proprietorship with your state but if you plan to “do business as” as a separate name then it is possible your state will want your to register the name.
Step three is to obtain the necessary licenses and permits. Depending on your location and the nature of your business, you may need to obtain certain licenses or permits. Some examples of permits include a business license, professional license, health department permit, or zoning permit. Research the specific requirements for your industry and locality.
Do you plan to have employees? If you plan to hire employees or have a business bank account, you may need to obtain an EIN from the Internal Revenue Service (IRS).
If you don’t have employees and don’t require an EIN, you can use your Social Security number for tax purposes. This is a bit of a more streamlined approach and less hassle.
That’s it. You are set up and ready to go with your sole proprietorship. As we mentioned before, the biggest hurdle is local licenses and permits. That said, there are a few more tasks to do which are beneficial when setting up.
A Few More Items to Consider
Separate business and personal finances: We always recommended to open a separate bank account for your business transactions. Imagine you get audited, this helps maintain clear financial records and distinguishes personal and business expenses. It will also help during tax time.
Stay up to date on taxes: As a sole proprietor, you are responsible for reporting your business income and expenses on your personal income tax return. You should stay informed about your tax obligations, including self-employment taxes and any sales tax requirements. If you are unsure what these are, be sure to ask for help.
Consider insurance coverage: Are you in a risky business? Is there a possibility of getting sued? Assess your business’s insurance needs and consider obtaining appropriate coverage, such as general liability insurance or professional liability insurance. Some places even require it. Most state fairs won’t let you serve food unless you have insurance. Construction often requires insurance. The list goes on and on. You get the point, add it to your budget when starting a business.
Keep recording: While it’s not mandatory to start out as a sole proprietor, keeping good records is only going to help you. From expenses to sales receipts and more, getting a bookkeeping program out of the gate is usually worthwhile.
Consult professionals if needed: Depending on the type and complexity of your business it may be wise to consult with a lawyer, accountant, bookkeeper or tax professional for advice on legal and financial matters related to your sole proprietorship. This all comes at a cost and for most people, they just want to keep the costs low as a sole proprietor. That is great but know when to get help.
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What are The Costs of a Sole Proprietorship?
If you want one of the cheapest business structures to set up then it is certainly the sole proprietorship. While you can keep costs to a minimum, here are some you might want to consider:
- Pulling licenses or permitting fees
- If your state has a fee to register for “doing business as”
- Tax, accounting or lawyer fees
- Insurance
While most of these costs will come with any business structure, they are often the lowest with a sole proprietorship.
Do You Need to Register in Each State?
Generally, you don’t need to register with any state when starting your sole proprietorship business. If you plan to do business in multiple states then it is likely you’ll need to pull the appropriate permits or licenses for the areas you are selling or conducting business.
How Are Sole Proprietorships Taxed?
The taxation of a sole proprietorship is typically straightforward. As an owner, you’d include the income and expenses of the business on your personal tax return, using Schedule C (Form 1040). The net profit from the sole proprietorship is then subject to income tax at the owner’s individual tax rate.
Additionally, the owner is required to pay self-employment taxes, which include both the employer and employee portions of Social Security and Medicare taxes. The self-employment tax is calculated based on the net profit of the business and is reported on Schedule SE (Form 1040).
Lastly, it is important to note that sole proprietors are also responsible for making estimated tax payments throughout the year. You won’t have taxes withheld from your income like employees do. Making these estimated tax payments help ensure that the owner meets their tax obligations and avoids penalties for underpayment. If this is something you aren’t familiar with then consult a CPA. They can help you get this process sorted for your initial quarters and you can even take over afterward.
Should You Choose a Sole Proprietorship to Start Your Business? Final Thoughts
For a lot of small business owners, sole proprietorships are going to be the way to go. They are inexpensive, easy to set up and have pass-through taxation. There is always the drawback of unlimited risk but it’s something you’ll need to consider. Make sure you compare some of the other popular business structure types like LLCs, partnerships and corporations before you make a final decision on your entity type.
