One of the major decisions an entrepreneur has to make is how to structure their business legally. Factors affecting this decision including business type, legal issues and cost to set up. Most importantly, federal taxation of your business depends on how your business is formed.
Here are the options small business owners have:
- Sole Proprietorships
- S Corporations
- Limited Liability Company (LLC)
A sole proprietorship, is the most common and simplest form of business. Here are the pros of running a sole proprietorship.
Advantages of a Sole Proprietorship
Complete 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 like this control, others might be more comfortable with co-owners.
Easy Set Up
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 here.
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. You are required to pay Social Security and Medicare taxes.
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 can be easy and free to set up.
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.
What it Takes to Organize a Sole Proprietorship
Talk to an Expert
It’s always a good idea to speak with an attorney or financial professional about taxes and liability. There are free resources available to speak with a small business expert. Check with an SBA Small Business Development Center (SBDC) or a SCORE mentor.
Choose a Name
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.
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). Review this article from QuickBooks for more information: What is a DBA, Why Do I Need One and How Do I Set Up.
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.
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
- Some banks require an EIN before they’ll set up a bank account for your business.
Open a Business Bank Account
It’s important to keep personal and business expenses separate. Review this blog post to learn how to build business credit: 6 Steps to Establish Business Credit
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.
The IRS website has a chart below to help you determine some of the forms you need to file as a sole proprietor. Access the chart here.