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When it comes to setting up a business, the first thing you look for is a suitable business structure for your new venture. 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.
On this page, LLCBuddy editors shared their experience with forming and running a sole proprietorship. There are merits, demerits, and several other factors to consider before you make the final decision. This page covers almost everything about 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 or owner, and he is responsible for enjoying all the profits the business will earn in each financial period. 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 Sole Proprietorships
Generally, sole proprietorships are formed by small-scale businesses that 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 that 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, small businesses start with their hobbies as the business model is suitable for gaining permits to be a sole proprietor.
Example of a Sole Proprietorship Business
Let’s say you want to start a dancing studio and you don’t hire any working partners. In this case, you will be the sole owner of your studio, whether you teach or hire full-time teachers. Once you proceed to register your studio, you have to choose a business structure. Now, except for a general partnership or any partnership structure, you can choose any type, such as LLC, PLLC, or a sole proprietorship. These options are suitable for small and professional businesses.
Other than a Sole Proprietorship, all other structures need a thorough registration process and complicated paperwork. So, the best option you will have is to go for a proprietorship business where you will be the owner, and the profits and losses will be on your shoulders. You will be liable to pay the business taxes on your profit. However, you wouldn’t have the legal separation exposure with this particular business idea.
Owner’s Role in Sole Proprietorship Business
You must first understand the proprietor’s responsibility in a business. This particular business is not a separate legal entity from the owner. Hence, you will be responsible for signing the checks, drawing the lease agreements, filing taxes, and other documents with your name on them. If your business is receiving any 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 to represent 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, the personal tax return will be the same even with the DBA.
Employees and EIN
In such business structures, the sole owner can get an EIN number from the Internal Revenue Service. The Employer Identification Number (EIN) is a nine-digit ID that will become the social security number of your proprietorship business entity. 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; hence, you will be responsible for paying the personal income tax and self-employment tax from the earnings you make every year. To file the income tax return documents yearly, you can look for professional consultants like LegalZoom.
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:
Easy to establish: One significant reason for starting this formal business structure is its ease of use. To become 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. You will sign the documents related to the business and make the business decisions. The reports received will be sent to your name.
Can make 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 reliably, with minimal conflicts of interest.
Efficient operations: A sole proprietorship is well-known for its simplicity and efficiency in 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:
No benefits on sole proprietorship taxes: No matter how much you have to pay as income taxes or self-employment taxes, the Federal Government wouldn’t give you any benefits from the taxation.
No protection for 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 loans associated with your business, you will be liable to pay off the business debts and other liabilities.
F.A.Qs
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.
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.
One of the key benefits of starting a sole proprietorship is the ease of formation. Unlike other business structures such as partnerships or corporations, setting up a sole proprietorship is relatively uncomplicated and requires minimal paperwork. In most cases, all that is needed is to register a business name, obtain any necessary licenses or permits, and start operating the business. This simplicity makes it an attractive option for those looking to get started quickly and without a lot of red tape.
Another advantage of a sole proprietorship is that the business owner has complete control over all aspects of the business. From decision-making to financial management, the sole proprietor retains full autonomy and is not required to consult with partners or shareholders before making important decisions. This can be a major factor for individuals who want to maintain a hands-on approach to running their business and are looking for more flexibility in their operations.
Additionally, a sole proprietorship offers tax advantages that can be appealing to many business owners. The income generated by the business is reported on the owner’s personal tax return, simplifying the tax process and potentially allowing for certain deductions and credits that may not be available to other business structures. This can result in significant savings for the owner, especially in the early stages of the business when every dollar counts.
Despite the benefits, there are also challenges to consider when starting a sole proprietorship. One of the primary drawbacks is that the owner is personally liable for all debts and obligations of the business. This means that if the business incurs debts or is sued, the owner’s personal assets may be at risk. It is important for prospective sole proprietors to carefully consider this risk and take steps to protect themselves, such as obtaining adequate insurance coverage or establishing a formal business entity.
Another potential downside of a sole proprietorship is the limited ability to raise capital. Because the business is owned and operated by a single individual, it can be challenging to attract investors or secure loans from financial institutions. This can limit the growth and expansion opportunities for the business, especially in competitive industries where access to capital is crucial for success.
In conclusion, starting a sole proprietorship can be a viable option for individuals looking to start a small business with minimal hassle and enjoy the benefits of autonomy and financial control. However, it is important for prospective business owners to carefully weigh the advantages and disadvantages of this business structure and take steps to mitigate any risks associated with personal liability and limited access to capital. By doing so, entrepreneurs can set themselves up for success and work towards achieving their business goals.
In Conclusion
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 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.