With so many different business options, it can be a real challenge to choose the best one. One of the most basic choices that you can get in the market is that of sole proprietorships. But what is a sole proprietorship? We will try to answer that here.
On this page, you’ll learn about the following:
- What Is a Sole Proprietorship?
- How Sole Proprietorship Business Works
- Advantages and disadvantages of a sole proprietorship
What Is a Sole Proprietorship?
A sole proprietorship is an unincorporated business, which means it wouldn’t be under the supervision of government rules, unlike limited liability companies, corporations, and so on.
Even though the sole proprietorships put a lot of restrictions on the owner, it is the easiest way to establish oneself in the market, all thanks to the simplest business form it supports. Since government regulations are not imposed on this type of business, one won’t have to deal with any kind of complications at the time of starting the proprietorship business.
Here, only one person acts as the proprietor owner, and he is responsible for enjoying all the profits the business will earn in each financial section. However, he will also be responsible for handling the losses, legal lawsuits, and other setbacks. The taxes that the proprietor needs to pay will be a part of the total profits he has earned.
Characteristics of Small Businesses Ceclared as Sole Proprietorship
Generally, the sole proprietorships are formed by the small scale businesses who don’t want to abide by the legal complications and waste more time in fulfilling them rather than setting up their businesses.
However, for a small scale business to become a sole proprietorship company, there are certain criteria which it needs to fulfill.
- The business should have a low risk of business and personal liability, losses, legal lawsuits, and bankruptcy.
- The profit increase formulated for the SMBE should be small with an amount that can be gained easily within the stipulated time period.
- The customers targeted by the small-scale business must be within a small radius, like the locals, families, friends, and others.
- Usually, the small businesses have started with their hobbies as the business mode are suitable for gaining permits to be a sole proprietor.
Sole Proprietorship Example
Let’s say you want to start a dancing studio. But, for establishing a company, you will have to meet certain requirements, which are not possible for a single-standing business with not much capital investment. So, the best option you will have is to go for a proprietor business where you will be your owner, and the profits and losses will be on your shoulder. You will be liable to pay the business taxes from your profit. However, you wouldn’t have the legal separation exposure with this particular business ideal.
How Sole Proprietorship Business Works
What you must first understand is the responsibility of the proprietor in a business. This particular business is not a separate legal entity from the owner, and hence you will be responsible for signing the checks, drawing the lease agreements, filing taxes, and other documents with your name on them. In fact, if your business is receiving any kind of payment, the document will have your name on it.
Can Any Other Name Be Used for Legal Works in Sole Proprietorship?
Yes, it is possible for a proprietor to use a fictitious name for representing this particular form of business in legal terms. For this, you need to register yourself with another name under the rule of DBA or “to do business as.” Once your filing is accepted, you will be able to work with another identity rather than your own. However, even with the DBA, the personal tax return will be the same.
Employees and EIN
In such business structures, the sole owner can get an EIN number from the Internal Revenue Service department.
What Is an EIN?
The Employer Identification Number (EIN) is a nine-digit ID that will become the social security number of your proprietorship business entity.
What Is the Purpose of an EIN for a Sole Proprietor Business?
With the EIN number, you will be able to open a business bank account, hire employees, calculate tax on employees, and perform other business activities.
Taxes Levied on Sole Proprietorship Business
Even though sole proprietorship entrepreneurs act differently than incorporated businesses, taxation will be levied on your business. It’s a one-person business, and hence, you will be responsible for paying the personal income tax and the self-employment tax from the earnings you are making every year. for filing the income tax return documents every year, you can look for professional consultants like Legal Zoom.
Advantages and disadvantages of a sole proprietorship
While there are significant upsides to setting up a sole proprietorship, there are also downsides to consider. Here are the advantages and disadvantages of a sole proprietorship.
Advantages of a Sole Proprietorship
Easy to establish
One significant reason to start this formal business structure is its ease of use. For becoming the sole proprietor owner, you won’t have to go through several legal complications, unlike other companies, including the Limited Liability Company.
Exercise full control over the business
Even though the sole proprietorship taxation will be levied on your profits, you can still have full control over this unincorporated business entity. It is you who will sign the documents related to the business, and also, the documents, take the business decision and reports received will be under your name.
Can take quick and reliable decisions
You will have full ownership of the company, and hence you won’t have to discuss anything with others. This way, the decision-making process can be made faster and more reliable, with minimal conflicts of interest.
A sole proprietorship is well-known for the simplicity and efficiency in the operations. There will be no one other than you who will be operating the business, and hence, the authority will rest in your hands. That’s the reason why the proprietors enjoy the smooth flow of commands and requests throughout the business.
Disadvantages of a Sole Proprietorship
No benefits on sole proprietorship taxes
No matter how much amount you have to pay as the income taxes or the self-employment taxes, the Federal Government wouldn’t give you any benefits of the taxation.
No protection to personal assets
With the sole proprietor business model, you wouldn’t be able to enjoy unlimited liability. You will be responsible for dealing with the business losses and other forms of risk associated with the unincorporated entity.
Need to pay off the debts on your own
If you have any loan associated with your business, you will be liable to pay off the business debts and other liabilities.
How to Start a Sole Proprietorship
Sole Proprietorship is owned by an individual. You can start it without any formal action. You just need to obtain all the necessary licenses and permits for the product/service offered.
A sole proprietorship is the simplest business entity to set up. As long as you are prepared to spend some money upfront, you can easily start a business from scratch. The advantages of a sole proprietorship include low start-up costs, a quick and simple process, and a lack of formal paperwork. However, there are also some disadvantages.
One of the biggest drawbacks of a sole proprietorship is the amount of liability it carries. Even if you have done everything in your power to protect yourself, if a customer claims you were negligent in performing a job or you violate a law, you could end up liable for the expenses of the claim. Also, some industries require you to have workers’ compensation insurance.
When it comes to starting a sole proprietorship, it is important to take the time to check out the laws in your state. Depending on the type of business you plan to operate, there may be different licenses and permits you need to obtain.
Some states require you to register a DBA (doing business as) name, which is a fictitious business name. This is a helpful tool if you are opening a business bank account. It can be useful if you want to get a business credit card, too.
You can also apply for an Employer Identification Number. This nine-digit number is issued by the IRS and identifies your business when you pay taxes. Many banks will require you to have this number in order to open a business bank account. In some cases, the process of getting this number is as simple as completing an online form.
If you are planning on hiring employees, you will also need to get an EIN. Getting an EIN is a relatively simple process, and you can do it right on the IRS website. Using an EIN will also reduce the risk of identity theft.
If you are starting a sole proprietorship, it is recommended to have a separate business bank account. This can help you keep your personal and business finances separate, which can be helpful if you are trying to build a good credit history. Separate bank accounts also give you an advantage when it comes to making payments to other businesses.
If you are ready to get started, contact your local Small Business Development Center. They can help you decide on the best business structure for you. Typically, a small business development center can help you find the right information and forms to help you start a sole proprietorship.
Another important step in starting a sole proprietorship is to get a business license. Before you can obtain a business license in your jurisdiction, you must obtain a state and federal license. Your local small business development center can help you determine if a state license is required for your business.
Other than the usual licenses, there are a few other considerations. For example, you will need to get a business telephone number and email address. Additionally, you will need a website for your business. And, you may need zoning clearance, as well as other licenses and permits.
The sole proprietorship income is earned from the business bank account from where you will be able to draw the money as part of your profits.
A self-employed sole proprietor is not similar to that of the limited Liability Partnerships because an LLC, there is a legal separation between the partners and the business. However, in a sole proprietorship, business ownership is not separate from the individual.
Sole proprietorship is a business structure for a single owner. The management structure is similar to a single-member LLC. For a sole proprietorship company, the owner has all the right to make decisions. If you are about to start a sole proprietorship company then refer to this article. Tell us more about your experience by commenting below.