“Starting a company as a sole proprietorship demand no set up except figuratively ‘hanging out your sign’ and possibly obtaining a fictitious business name. No wonder, there are various things you should do, in addition, but starting a company as a sole proprietor seems one of the easiest ways to go,” says Kristen Hayes Kuse, attorney at Integrated General Counsel.
A sole proprietorship is the default company structure you will assume if you are doing business and have not set up any other business type. According to the U.S. Small Business Administration (SBA), 73% of small businesses in the U.S. are sole proprietorships.
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And around 24.6 million people do non-farm sole proprietorship activity in 2014, As per the report of the Internal Revenue Service (IRS). As Kuse believes, “You don’t need to worry about doing things to start a sole proprietorship apart from conducting business, but there are steps you need to take to make your business a successful one.”
We have come up with the following guide on how to set up a sole proprietorship, its financial structure and the potential drawbacks and limitations of starting one.
A sole proprietorship is a business operated and run by an individual and has become a dream for many people. These businesses, which are not registered as an LLC (limited liability company), a partnership, or a corporation, have the benefit of flexibility. Sole proprietors also have the opportunity to work as freelancers — independent contractors — or they can run physical on-the-ground businesses.
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Often, home-based businesses are sole proprietorships. There are around 23 million of these in operation today, vastly more than any other traditional forms. This sort of business carries dangers with it, and it’s important to understand them so you can avoid pitfalls in bookkeeping, taxes and other potential liabilities.
Starting a sole proprietorship business appears quite an interesting idea here you are the only boss of your business or company.
A sole proprietorship is a business that requires one person or an individual, unlike corporations and limited liability companies (LLCs), who do not necessarily have to register with the state in order to exist. If you are the sole owner of a business then you become a sole proprietor simply by conducting business.
And there is no complex process is required establishing a sole proprietorship, there may be local registration, business license, or permit laws you need to comply with in order to make your business legitimate. Also, you must be aware of your income tax and business debt obligations because as a sole proprietor you are personally responsible and liable for repaying your debts.
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The primary advantage that makes this kind of business attractive is that it is pretty much easy. You do not even have to register a name. Just operate under your own name, or pick a name, choose a location and get up and running. Many people set up a business checking account, but you do not necessarily even have to do this.
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A sole proprietorship does not require separate small business taxes to be filed. They are simply reported on your personal taxes using Schedule C on Form 1040 in the U.S. or the TI tax form in Canada. In addition, if your business is home-based, you can deduct all business-related expenses, and any losses your business suffers count as deductions.
The Small Business Administration (SBA) reports that tax rates for small business or a sole proprietorship are lower than any other form of business at 13.3 percent, compared to the 26.9 percent that S corporations pay.
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LLCs with only one member might pay sole prop taxes, whereas LLCs with multiple members pay taxes as partnerships. In partnerships, any income is taxed at the personal tax rates of the partners, and in corporations, shareholders pay business taxes at corporate rates.
Of course, the lack of separation between personal and business expenses and assets creates some risks. Unlike a registered corporation, you do not enjoy limited liability, which separates any business problems from the individual. You can be held responsible for any damages from lawsuits, failed business ventures, or other problems. More importantly, you also have less flexibility in tax reporting with a proprietorship business.
If you file bankruptcy, even Chapter 11 reorganization, that means putting your house, car and other personal assets on the line.
In addition, other problems with this kind of venture include potential difficulty landing jobs and raising capital, as many will not contract with an unincorporated business. Venture capitalists, angel investors, and other entities see a risk in the lack of separation between person and business. There is a perception of a lack of professionalism in single-owner, unincorporated businesses.
Finally, when you want to get out of your business, even if you get a great offer, it can be difficult and tricky to sell an unincorporated business. It is hard to value your business when it is tied to your personal assets. In addition, when you pass away, the business is simply worthless and just ends, with nothing left for your descendants or heirs.
An infinite number of businesses function as a sole proprietorship but consider these common examples.
(a) Accountant: An accountant or bookkeeper helps other businesses keep financial records; tracking expenses, profits, revenue, payments, and other financial data for accounting purposes. This helps businesses accurately file taxes every year and keeps an accurate record of their finances.
(b) Caregiver: There is always a need for health care providers in-home. These businesses often cater to seniors and include not just medication and medical needs, but companionship, hygiene, cleaning, cooking, and daily tasks.
(c) Financial Planning: Financial planners help people with end-of-life decisions like wills and estates, or with business formation and exit plans, retirement, college savings, investments, and other major financial events.
(d) Landscaping: Landscaping businesses help people keep their yard looking beautiful and do everything from planting flowers to cutting the grass to re-terracing and shaping the land. They might employ a number of workers.
(e) Computer Repair: These companies are often run by a single person working out of the home troubleshooting hardware and software problems for clients and keeping computers running like new.
(f) Housekeeping: Housekeeping services, which travel around to clean and organize homes, are often single-owner affairs, though like landscapers they may hire several employees.
(g) Freelancer: Freelance writers, artists, and graphic designers make a living plying their art on a sole proprietor basis, taking on jobs as a contractor or starting companies of their own.
(h) Tutors and Trainers: Tutors help with everything from difficulty with mathematics homework to corporate training in best practices and sensitivity seminars.
(i) Virtual Assistants: These administrative professionals work to help business owners and executives take care of administrative needs through the internet, from answering e-mail to drafting documents to record-keeping and more.
Sole proprietorships require a piece of the cake-like process to set up and maintain that you may already own one without knowing it. For example, if you are a freelance photographer or writer, a craftsperson who perform their jobs on a contract basis, a salesperson who receives only commissions, or an independent contractor who is not on an employer’s regular payroll, you are automatically a sole proprietor.
However, even though a sole proprietorship is the simplest of business structures, you should not fall asleep at the wheel. You may have to comply with local registration, business license, or permit laws to make your business legitimate. And you should be attentive and sharp when it comes to tending your business because you are personally responsible for paying both income taxes and business debts.
Starting a sole proprietorship business is takes a simple process to be carried out. The first step is to have an idea for a product or service you want to sell. You need to devote the necessary time and work into your startup and learn about proper business practices and accounting principles.
Once you become a little bit aware of a sole proprietorship, whether it means selling a product or providing a service, make the decision to run your activity like a business. “Prepare yourself to spend your time, make a good of business methods, and set up properly so you can make more money, minimize taxes, and avoid potential problems,” says Barbara Weltman, a tax and business attorney and author of these books as J.K. Lasser’s Small Business Taxes (Wiley 2010).
There are no formal legal steps required to register a sole proprietorship business. Just by conducting business, you re already a business owner. Some cities and municipalities require you to register your business with the local government or get an occupancy license, as well as potentially paying local business tax. Contacting your local SBDC (Small Business Development Center) office is of great use in this area.
Thus, in order to be a sole proprietorship, you do not have to take any formal or legal steps at the federal, state, or local level, Weltman says. “Until you are the only owner of your business, you automatically become a sole proprietorship and responsible,”.
Based upon the city or municipality where you set up shop, you may need to register your business or obtain business and/or occupancy licenses. Osteryoung recommends contacting the nearest government-sponsored Small Business Development Center (SBDC). The Small Business Administration maintains an SBDC locator. They can usually offer step-by-step instructions guide on how to set up a sole proprietorship by obeying all local laws and regulations.
One key component of starting a business is writing a business plan. The plan serves as a roadmap does so you aware of the idea about the order in which to implement actions necessary to start and grow the business, Weltman says. It’s also useful to make you concentrated on various aspects of the business, such as obtaining start-up capital and deciding whether or not you will be selling through the Web.
Next, choose a name, register the web domain for it. If your business name is different from your name, register it as well to keep other people using it. The moment you start using this business name in commerce you can mark it with a Trademark symbol. If you wish to register the trademark for more protection, check out the USPTO website resources.
Running your business under a name other than your own is called “DBA” or “Doing Business As“.
A name must be described in one or a few words in order to keep it simple and easy to pronounce. Take your time as much as you want to consider carefully in choosing the best name when you are about to start up a sole proprietorship.
“Ensure the name you are using for Sole Proprietorship should not be taken by another business or an individual,” Osteryoung says.
(a) Pick a domain name: If you plan to create a website, as most businesses should, be sure that you select a domain name — hopefully one that is the same as your business name, Weltman says. Even if you do not set up a website immediately, reserve the name by registering your site. Check the availability of the name you want to use through Register.com.
(b) Register your name: If you operate the business under your name, as do many freelance writers and business consultants, you can skip this step. And if you operate under a fictitious name, you should register it — you’re required to and it prevents someone else from using the same name in your area, Weltman says. “For example, if Jane Jones runs a dog walking business under the name Pampered Puppies, she should file with her local government that she is ‘doing business as’ (DBA) this fictitious name,” she adds. “Contact your local government — often the county for ensuring that your sole proprietorship name is not already being used by another business.”
(c) Trademark your name: As Weltman says, “While not mandatory, it’s often a good idea to gain legal protection for a business name so that no one else can use it.” It becomes crucial when your name recognizes as a brand and gains popularity. Know about the trademark protection through the U.S. Patent and Trademark Office.
When you work as a sole proprietorship, even though your personal and business assets intertwine, you want to separate your financial activities. This is of great use when you prepare your tax returns and financial statements, as your business assets and losses have a major impact on your taxes. Because of this, you want to set up a business bank account that’s only for your business activities, get a business credit card and acquire software to track your business records. Keep your business finances as separate as possible from your personal activities.
This matters because, for the first several years of your business, you suffer a lot of losses that are 100 percent deductible. You have to pay self-employment taxes after you start making a profit, which is done quarterly based on your estimated taxes. If you reselling products, you may have to pay a sales tax based on your local rates.
Besides tax liabilities, the single greatest risk to the owner of a sole proprietorship is legal liability. In order to protect yourself from accidents, unforeseen circumstances and lawsuits, get a solid insurance policy. There are multiple types of business insurance you would like to think about.
(i) Auto Insurance: if you plan to use your personal vehicle for business purposes, you want to extend your auto coverage for this purpose. Most insurance companies will not cover the business use of personal vehicles without a proper policy add-on.
(ii) Property Insurance: Your homeowner’s policy will not necessarily protect you if a disaster happens on your property while you are using it for business. Make sure that you have business coverage.
(iii) Liability Coverage: In addition, every business runs the risk of being sued for any number of things. The right liability coverage protects your personal assets should you be the target of a lawsuit.
(iv) Health Care: Unless you have health insurance through your spouse or through a former employer, you want to check out the Healthcare Marketplace or seek personal insurance another way. Also, consider disability coverage since you will not have workers’ compensation.
A sole proprietor is personally liable for any business-related obligation. This means that if your business does not pay a supplier, being defaulted on a debt, or loses a lawsuit, the creditor is entitled to come after your house or other possessions.
Example 1: Lester is the owner of a small manufacturing business. When business prospects and hopes look good, he orders $50,000 worth of supplies and uses them in making merchandise. Unfortunately, there’s a sudden drop in demand for his products and Lester cannot sell the items he has produced. When the company that sold Lester the supplies demand payment, he cannot pay the bill.
Being a sole proprietor, Lester is personally liable for this business obligation. This means that the creditor has the right to file a case against him and take control of not only Lester’s business assets but his personal property as well and which will include his house, his car, and his personal bank account.
Example 2: Shirley is the owner of a flower shop. And one of Shirley’s employees is offering flowers using a truck owned by the business. Roger strikes and seriously injures a pedestrian. The injured and affected pedestrian filed a case against Roger, claiming that he drove carelessly and caused the accident.
The lawsuit names Shirley as a co-defendant. After a trial, the jury returns a large verdict against Shirley as an owner of the business. Shirley is personally liable to the injured pedestrian. This means the pedestrian can possess all of Shirley’s assets, business and personal.
By contrast, the law provides owners of corporations and limited liability companies (LLCs) with what’s called “limited personal liability” for business obligations. Meaning, unlike sole proprietors and general partners, owners of corporations and LLCs can still keep their possessions such as a house, investments, and other personal property with them even if their business fails. If you will be engaged in a risky business, you may want to consider forming a corporation or an LLC.
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For the law, a sole proprietorship is not legally separate from the person who owns it. Instead, it is known as a pass-through entity for tax objectives. A fact is known to all now that a sole proprietorship and its owners are one and the same means that a sole proprietor simply reports and submit all business income or losses on his or her individual income tax return — IRS Form 1040, with Schedule C attached.
As a sole proprietor, you’ll have to take responsibility for withholding and paying all income taxes — something an employer would normally do for you. This means you’ll have to pay a “self-employment” tax, which consists of contributions to Social Security and Medicare and pay estimated taxes throughout the year.
Given below are few more tips from sole proprietor Steven Hausman, Ph.D., and President of Hausman Technology Consulting.
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Whenever you initiate the process of setting up a sole proprietorship, you should consider separating your personal finances from your business. This helps you prepare financial statements (so you know whether you are making or losing money) and prepare tax returns. Weltman recommends establishing the following to set up business finances
Also, Weltman adds, “Keep business finances and records separate from your personal activities to show the IRS that you are conducting the activity with the intent to make a profit, so that losses, which usually happen during initial level or years, will be deductible.”
“If you are thinking to start mingling personal and business finances it can get messy in terms of taxes and family,” Osteryoung said.
Be prepared for paying taxes. Being a sole proprietor you should file an annual return with the IRS to report and register your business income and expenses; use Schedule C (or, if eligible, a simplified Schedule C-EZ), which is an important part of Form 1040.
If you have no team or employees, then the business can operate under your Social Security number, Weltman says. However, once you hire staff or set up a retirement plan, you’ll need a federal employer identification number (EIN), which you can obtain online at no cost from the IRS.
“If the business is generating a huge amount of profit, you will owe self-employment taxes,” Weltman says.
Because you are self-employed, you do not have withholding from a paycheck to cover your tax obligations. Instead of paying income and self-employment taxes through quarterly estimated tax payments (you should set aside money on a regular basis to cover up these payments). “When you file your return for the year, you will then pay any shortage or receive a refund if you’ve overestimated your quarterly payments,”.
Contact and consult your locality to learn and discover about sales tax collections. And you may be required to collect sales taxes on the goods and services you sell and to turn over your collections to the state, as well as to report on collections on sales tax returns.
One of the biggest reasons for arguments against setting up a business as a sole proprietorship is that, as a sole proprietor, you can be held personally liable for any and all business-related obligations. So, if your business defaults on a loan, fails to pay suppliers, or loses a suit in court, creditors can legally take control of your personal possessions — even the roof over your head.
That’s why many businesses have the desire to select incorporate or establish low limited liability corporation– those forms offer you personal liability protection for those same business-related obligations. If your LLC company or business faces failure then, you as an owner can still have a chance to keep and take your house and other personal property.
If you like to be a sole proprietor, the best way to protect yourself is to obtain and avail adequate insurance coverage for the unexpected. Weltman advises sole proprietors to consider the following
“If you are about to invest and spend a large amount of time and money in initiating and starting a business, Plan also about to review your plans with experts,” Weltman says. “Bring forward the decisions you made with an attorney, accountant, insurance agent, Web designer, for additional guidance.”
A sole proprietorship takes a simple process to be implemented and also, it is perfect for the business owner on a solo venture. You can make all of the decisions and will have total control of the direction your company goes in.
However, you need to be aware of several implications and signs of warning, such as the full liability you hold, tax responsibilities and the legal requirements for your business. Stick this list on the wall so that you will certainly take a look at when you have an idea to start your sole proprietorship company on the right foot.