One of the major decisions an entrepreneur has to make is how to structure their business legally. A major factor in this decision is the size of your business. If you’re starting a business on your own , a sole proprietorship is likely the most suitable structure. Even if you do have employees, you can still qualify as a sole proprietor if you, and only you, own your company. Classifying yourself this way can be highly beneficial. The sole proprietorship advantages below explain why.
What is a sole proprietorship?
A sole proprietorship is the most common and arguably the simplest form of business. It describes any unincorporated business with one owner, whether or not the company has employees.
Sole proprietorships are only one of several structure types from which business owners can choose. Some other options small business owners have include:
- Sole Proprietorships
- Partnerships
- Corporations
- S Corporations
- Limited Liability Company (LLC)
It’s worth noting that the IRS doesn’t recognize LLCs for tax purposes. If you have an LLC, you must instead designate it as a partnership or a corporation for federal taxation. However, if you classify your LLC as a corporation on your tax returns, your business loses its sole proprietorship status.
Who can be a sole proprietor?
As described above, anyone who owns a business alone – regardless of whether they have employees – can qualify as a sole proprietor. Freelancers and gig economy workers can also be classified as sole proprietors.
If you’re a freelancer seeking to formally register as a sole proprietor, you’ll first need to decide on a business name separate from your legal name. You’ll then need to take the appropriate steps to organize all your business affairs under that name and formally register that name.
Many freelancers ultimately choose to work as ordinary self-employed people instead of formally registering as sole proprietors. This common decision largely stems from the fact that sole proprietors and freelancers are taxed in exactly the same way. Freelancers may benefit more from creating an LLC for their business affairs, but as mentioned earlier, LLCs cannot be sole proprietorships.
Sole proprietorship may be more appropriate for a small business owner with no partners than for an ordinary freelancer. Sole proprietorship is also all but required if you’re a sole business owner with employees. However, in this case, you can also choose other business structures. Below, find information to help you decide whether a sole proprietorship, or one of these other structures, is a better fit for your business.
Advantages of a Sole Proprietorship
Here are the pros of running a sole proprietorship:
1. Total Control and Decision Making
As the only owner of a sole proprietorship, you are in control and can make all the decisions about your business. You won’t need to consult partners or other stakeholders. Some business owners prefer this control, others might be more comfortable with co-owners. Additionally, since you have complete control and business ownership, you’ll never need to address a corporate board or draft articles of incorporation. That’s not just convenience – that’s time saved.
2. Easy Setup
A sole proprietorship is not considered a formal business structure. This lets you avoid filings and paperwork to set up. To start a sole proprietorship you’ll need to choose a business name, establish a location, and set up a business checking account.
Be aware of federal, state and local permits, licenses and registrations required for your business in your location. The SBA has a licensing and permits tool to help you better understand the requirements here.
3. No Corporate Taxes
Sole proprietors are not considered an employee. The IRS considers sole proprietors as “self-employed.” You must report business income and losses for the year as personal taxes . You are required to pay Social Security and Medicare taxes , also known as self-employment taxes .
4. Easy, Minimal Reporting Needs
Since sole proprietors file their business taxes as personal taxes, you don’t have to file separate business and personal tax returns. Additionally, since sole proprietorships don’t have shareholders or corporate boards, you won’t need to create corporate reports. The amount of time saved is invaluable.
5. More Privacy
The lack of corporate reporting required of sole proprietorships gives you more privacy. You won’t have to create any documents that publicly disclose how you’re running the show or reveal your finances to anyone but yourself. If you prefer to have minimal outside influence on your affairs, you might place a high value on this level of privacy.
6. Low Legal Costs
The complexity increases if you form a corporation. Business owners will almost always need an accountant or attorney. Forming an LLC can also be costly. A sole proprietorship, on the other hand, can be easy and free to set up.
7. Few Formal Business Requirements
A sole proprietorship is the easiest and simplest way to go into business. You'll avoid tediously filing paperwork and keeping up with document requirements. There are no articles of incorporation to create or no forms to file with the IRS to indicate your business structure. Instead, you can just get your business up and running without looking back.
8. Simple and Affordable
The key takeaway of all the above sole proprietorship advantages is that being a sole proprietor is simple and affordable. If keeping costs low and operations uncomplicated is your priority over all tax and operational considerations, and if you qualify, then a sole proprietorship might be the best option for you.
Tips on How To Start a Sole Proprietor Business
To start a sole proprietorship, take the below steps:
1. Choose a Name and Find a Location
Choosing a name is free and easy. It gets more difficult when you start researching if that name is taken and trademarked. Search the US Patent and Trademark Office to find out if the name you’ve chosen has been trademarked.
After you come up with a business name, figure out where your company will be located. You can run your business from home, or you can rent a storefront or traditional office. Then, jot down your business address. You’ll need both an address and name to proceed with the process.
2. Register for a Business License
In most cities, even sole proprietorships need a business license to operate. You might face steep fines if you don’t take this step.
To obtain a business license, contact your city or county licensing authority. You must do this even if you plan to operate your business from home, as even home businesses require licensure. Depending on your business type, you may also need professional, health, safety, and signage licenses and permits, even if you operate from home.
3. Open a Business Bank Account
It’s important to keep personal and business expenses separate. To find out why, read the SmartBiz Loans ® guide to separating your business and personal finances.
A business bank account proves to the IRS that you’re running a business to make a profit.
Another important reason to have a business bank account is that losses during the first few years will remain tax-deductible. Opening a business bank helps to build good credit history.
4. Register with Your State Taxation Authority
If your sole proprietorship offers taxable products or services, you must register your company with your state tax authority. Yes, your business and personal tax returns are one and the same as a sole proprietor, but this fact doesn’t exempt goods you sell from sales tax. The SmartBiz Loans ® guide to how businesses pay sales tax explains why this is the case. It also walks you through the registration process and helps you determine whether you must collect sales taxes.
5. Establish a Federal Employer Identification Number (EIN)
Also called a tax identification number, the EIN is a nine-digit number assigned by the IRS. This number is used to identify the tax accounts of employers and certain others who have no employees. According to NOLO.com, you must have an EIN to:
- Hire employees
- Have a retirement plan
- Buy or inherit an existing business that you operate as a sole proprietorship
- Incorporate or form a partnership or LLC
- File for bankruptcy
Additionally, some banks require an EIN before they’ll set up a bank account for your business.
6. Talk to an Expert
It’s always a good idea to speak with an attorney or financial professional about taxes and liability. There are some free resources available to speak with a small business expert. Check with an SBA Small Business Development Center (SBDC) or a SCORE mentor.
7. Register Your DBA
The legal name of your business, if you're a sole proprietor, is your personal name. If you want to operate under a different name you need to register a fictitious or “doing business as” name (DBA). To learn more, review the SmartBiz Loans ® guide to obtaining and paying for DBAs.
Next Steps
The IRS website has a chart to help you determine some of the forms you need to file as a sole proprietor. You’ll find forms for estimated taxes, FICA taxes, payments to nonemployees, and other key considerations. The chart makes it easy to figure out which of the 10 most common sole proprietorship tax forms you need to complete and file.
