What Is a Sole Proprietorship?
A Sole Proprietorship is the simplest structure for operating a business owned by one person (or a married couple). By default, states will consider a single-owner business to be a Sole Proprietorship unless the owner (the sole proprietor) files business registration paperwork to form an LLC (Limited Liability Company) or a Corporation. Sole Proprietors are not considered employees of their companies. They get paid by withdrawing funds (taking “owner’s draws) out of their businesses for personal use.
Many freelancers, consultants, and other professional service providers work as Sole Proprietorships. The Sole Proprietorship structure is also attractive to entrepreneurs in other industries, too (retail, landscaping, cleaning, and more). It’s common for entrepreneurs to start as Sole Proprietorships and then register their companies as formal business entities when they begin to grow or expand their businesses.
How do Income Taxes and Legal Liability Work in a Sole Proprietorship?
A Sole Proprietorship is considered the same legal and tax-paying entity as its owner.
The owner is personally liable for the legal and financial debts of the business. So, if a Sole Proprietorship doesn’t pay its bills or gets sued by a customer or vendor, the owner’s personal assets (home, car, checking and savings accounts, etc.) might be seized to settle those debts.
Sole Proprietorships are “pass-through” entities for income tax purposes. Business profits and losses flow through to the owner’s personal tax returns. Also, all of a Sole Proprietorship’s profits are subject to self-employment taxes (Medicare and Social Security); that’s because the owner doesn’t receive a paycheck from which those taxes are deducted. Generally, Sole Proprietors must make quarterly estimated tax payments to the IRS, state, and local tax authorities throughout the year.
How Do You Form a Sole Proprietorship?
Unlike a Limited Liability Company or C Corporation, a Sole Proprietorship is not a formal business entity. Sole Proprietors do not have to file business registration paperwork with the state. As soon as the owner begins to conduct business with the intent to make a profit, the Sole Proprietorship is established.
Sole proprietors may have to obtain certain types of business or professional licenses and permits to operate legally in their industry or location.
When sole proprietors do not want to include their first and last name in their business name, they must request to use a trade name by filing a DBA (“Doing Business As”). Some states call it a “fictitious name” filing. Depending on the business’s location, the fictitious name must be filed with the state or the county clerk.
For example, if Lena Caswell wants to market her new business by the name “Immaculate Image Consulting Services,” she would need to file a DBA to get permission to use that name with the state or county clerk office. Some states also require businesses to publish a notice about their fictitious name in one or more approved newspapers or other publications in the county where it was filed. In some states and counties, DBAs must be renewed periodically.
Filing a fictitious name does not provide any legal protection of the company name. Its purpose is to protect customers, vendors, and others from unknowingly doing business with shady owners trying to hide their real identity. It puts the owner’s identity on record as the person operating the company under the assumed name. To obtain exclusive rights to use a fictitious name, a sole proprietor must register it as a trademark through the USPTO (U.S. Patent and Trademark Office).
Advantages and Disadvantages of Sole Proprietorships
As with any business structure, Sole Proprietorships have some positive and negative qualities to consider.
Pros of a Sole Proprietorship
- It’s simple to start a Sole Proprietorship.
- Sole proprietors don’t have corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc., to fulfill.
- Tax reporting is relatively easy because everything flows through to the owner’s tax returns. Also, owners can deduct most business losses on their personal tax returns.
Cons of Sole Proprietorship
- The owner is personally liable for the business’s debts and other liabilities.
- It may be more difficult to get business loans or secure funding from investors.
- Some clients and vendors may not perceive the business as credible as a company with “LLC” or “Inc.” behind it.
- The pass-through taxation may not be advantageous financially to some entrepreneurs.
When Might the Sole Proprietorship Business Structure Be a Good Fit?
Operating a business as a Sole Proprietorship might be a viable option when an entrepreneur:
- Does not plan to reinvest money back into the business.
- Does not want to deal with compliance formalities.
- Does not have—and doesn’t intend to hire—employees.
- Will sell products and services that have minimal legal risks associated with them.
When choosing whether a Sole Proprietorship or other business entity type is ideal for their circumstances, entrepreneurs should consult with lawyers and accounting or tax experts for professional guidance. With many legal and tax considerations that can affect liability and financial outcomes, it’s crucial to have a firm understanding of the pluses and minuses before making a decision. Every business owner’s situation is different!
Sole Proprietorship Business Compliance Responsibilities
Running a business as a Sole Proprietorship comes with minimal ongoing compliance tasks compared to other business structures. Several responsibilities a sole proprietor may need to stay on top of include:
- Reporting and paying income and self-employment taxes
- Withholding and paying payroll taxes (if the sole proprietor hires employees)
- Renewing required licenses and permits (including sales tax permits, if applicable)
- Renewing fictitious names
States and local authorities may have additional requirements.
Get Your Business Started with CorpNet’s Help!
Whether you decide that a Sole Proprietorship or another business entity type is right for you, you can count on CorpNet to help you get your company up and running. Our filing experts are standing by to prepare and submit your online forms—no matter where you are in the United States—quickly and accurately. File a DBA, apply for business licenses and permits, register for payroll taxes, and more.
Contact us today to talk with one of our experienced team members and get started!