Sole Proprietorships: What to Know

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Are you starting a business and considering whether to do a sole proprietorship? We’ll explain everything you need to know about starting a sole proprietorship, advantages, disadvantages, taxes, and other common questions.

What is a Sole Proprietorship?

Sole proprietorships are unincorporated businesses run by a single individual. This is the most common form of small business, with 27.8 million sole proprietors in the US for the tax year 2019. According to the US Small Business Administration, the main characteristics of a sole proprietorship are:

  • One owner of the business: One individual owns and runs the unincorporated business.
  • Unlimited liability: The individual is entitled to all the profits, debts, and liabilities. There is no separating the business from personal accountability.
  • No legal entity: Because sole proprietorships are unincorporated, no formal legal action is needed to distinguish them as a business. While you don’t have to register your business officially, you may need specific permits and licenses.
  • One decision-maker: One person makes all the decisions for the business.
  • Terminate business anytime: the person can terminate the business whenever they want.

Sole Proprietorship Taxes

Because the business is the same as your personal income and liabilities, you do not need to submit separate taxes for the company. As part of your individual income tax, you must submit a schedule C that reports all income or losses for your personal tax return.

There are several IRS Forms for a Sole Proprietorship. You’ll need to withhold and pay income taxes, self-employment, and other taxes that might be associated with your business.

Advantages of Starting a Sole Proprietorship

There are some key advantages to starting a sole proprietorship:

  • It is easy and inexpensive to form the business: The legal costs only include permits or licenses specific to your business.
  • It offers complete control of decision-making: Because you are the only person in the business, you are not required to consult with a board or shareholders before making changes and decisions for the business.
  • It is simple to do tax preparation: You can simply include the income and liabilities on your personal tax form because the business is not taxed separately from you. Sole proprietors also enjoy the lowest tax rate for businesses.

Disadvantages of a Sole Proprietorship

There are a few disadvantages of a sole proprietor business:

  • Unlimited liability: The company is tied to you, and there is no legal separation. You are responsible for all debts, obligations, or risks that the business incurs. This means your personal assets may be used to fulfill debts and liabilities.
  • Challenging to raise money: Because the business is left to one person, it’s difficult to raise funds from investors or banks. Sole proprietors bring additional risks that banks avoid.
  • Full responsibility and pressure: While you get to make all the decisions, you also have to own all the consequences, good or bad.

Does your business require research and development? Learn how the TaxRobot software can save you money by tracking and managing your R&D expenses.

Related Link: Startups Can Get $250,000 From the IRS: Here’s How

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Step by Step on How to Start a Sole Proprietorship

Unlike corporations and LLCs that require state and federal registration, a sole proprietorship is much easier to form. There are three types of sole proprietors:

  • Independent contractor
  • Business owner
  • Franchisee
  1. Determine what type of sole proprietorship you want to do and if it is the smartest structure for your business.
  2. Do your research and talk to experts, like your local small business development center, to determine your state, city, and county requirements for legally operating a sole proprietorship.
  3. Choose a name for your business. This may require more research if you need to get a website or trademark with the same name.
  4. Register your business name for “doing business as” (DBA). You only need to do this if you are not using your personal name as your business.
  5. Buy your domain name. Most businesses will need a website. Hence the importance of the earlier research.
  6. Register for a business license. Most cities require that you have a business license to operate as a sole proprietorship.
  7. Research and apply for any other permits or licenses at the federal and state level for your type of business. These permits could be:
    1. Health Department
    2. Federal License for Transporting Animals
    3. Health and Safety (for a daycare)
    4. Certifications for Your Profession
    5. Zoning Permits
    6. Registration for State Tax (if you have employees or collect sales tax)
  8. Register for an employee identification number (EIN). This is only necessary if you hire employees. Otherwise, you can file taxes under your social security number.
  9. Open a business bank account to keep your personal and business expenses separate, which will come in handy for taxes or potential audits.
  10. Get business insurance. Because sole proprietors run the risk of liability, it may be good to get insurance to help shoulder the burden.
  11. Hire a great accountant to help file your taxes. Accountants specializing in startups and sole proprietorships will be worth their weight because they will know all the tax breaks needed to minimize your taxes.
Working professional woman sitting at computer

Sole Proprietorships are a Smart Business Structure for Self Businesses

If you are a freelancer, franchisee, or business owner and you don’t have any employees, then a sole proprietorship is a smart business structure for your business. If your business evolves, you can always reform as a corporation or LLC.

If you need tax help or advice on starting your business, you should talk to one of our consultants about what would be the better business structure for your business from a tax perspective.

TaxRobot offers a powerful AI-powered tax tool for startup businesses. Maximize your tax benefits with our intuitive software that automates expenses to be counted toward specific tax credits to save you money.

Want to learn more about how our automated tax software can save you money on your tax return? Contact us to see a demo.

Related Link: How Startups Benefit from the IRS Seed Stage

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