One of the easiest ways to establish a business as a sole trader is to register as a "sole proprietorship". A sole proprietorship is common to private contractors or consultants who operate a one-person business.
What is a Sole Proprietorship?
A sole proprietorship is a business that doesn't have a different existence from its owner. It's not a legal entity like a corporation but a person who owns and takes on the liability of a business.
Advantages of Sole Proprietorship
Easy Registration Process
A sole proprietor can register with a fictitious or personal name to secure a business license. The account and invoice of the business will carry either the personal name or the fictitious name used by the proprietor.
The registration process for sole proprietorship requires little paperwork, making it easy to establish a business. Usually, permits and licenses are the main requirements to operate a sole proprietorship. There is no need to register with the state or pay any form of the annual fee.
The tax payment process is simple for a sole proprietor. The business owner pays taxes via a personal account since the business is not separate from the owner. Using the Schedule C and standard form 1040, profit and losses are filed through a personal tax return. The advantage here is that losses recorded can serve as tax benefits.
The tax process is also simpler because an employer identification number is not necessary. The social security number of the owner will suffice for the business.
Disadvantages of Sole Proprietorship
Exposure to Risk
A sole proprietor is liable to risk associated with the business.
For example, if your business fails to pay a vendor, defaults on a debt, or loses a lawsuit, the creditor can legally take your house or other possessions.
Debts incurred by the business are paid by the individual and personal assets are vulnerable to lawsuits. In situations as cited above or other circumstances, the business owner bears the brunt of business crises.
Another form of risk is mixing personal finances with that of the business. This can result in certain financial complications that can hamper business growth.
Difficulty Obtaining a Loan
Since a sole proprietorship is not incorporated, it's difficult to obtain a loan from financial institutions. Bank loans and similar loans are difficult to get since established financial institutions prefer to work with companies or firms with a good and reputable track record.
Lack of Continuity
In the event of the death of a sole proprietor, the business may not keep functioning. A corporation may keep existing because many individuals are part of the business. However, one individual makes a sole proprietorship and unless appropriate steps are in place, the business may not survive.
Is Sole Proprietor the same as self-employed?
Short answer, yes. As a sole proprietor, you are self-employed.
Therefore, a sole proprietor does not work for any company or boss, just for themselves.
How does Sole Proprietorship compare to other business structures?
Overall, sole proprietorship has a couple of advantages over other forms of business entities in terms of simplicity in setup and operation.
Registrations are not needed and taxes flow through the personal return of the owner since the business and the owner are the same.
How do you start a Sole Proprietorship?
A sole proprietorship can essentially be founded by just starting your business. No state registration is required.
Getting a business name is the first step, followed by applying for a permit or license with your city or state. In order to hire employees, you will need an employee identification number (EIN) from the IRS, and if you will be selling taxable products, you will need a state registration number.
Helpful resource: How to register your business
When should a Sole Proprietor become an LLC?
When you are serious about growing and earning a profit from your business, you should move from a sole proprietorship to an LLC.
A sole proprietorship is only suitable for businesses with a very low-profit margin/low risk.
LLCs allow business owners to take on risks and grow their businesses. An LLC protects the owners personally from claims.
Business activities that could make you liable to risk may are not usually suitable for a sole proprietorship.
Is a single-member LLC the same as a Sole Proprietorship?
No. Single-member LLCs are formal business structures with only one owner.
A single-member LLC is only taxed the same way as a sole proprietorship.
How are Sole Proprietorships taxed?
As a sole proprietor, you will need to complete the standard tax Form 1040 and the Schedule C, which reports the profits and losses of your business.
You will owe taxes based on your combined income from Form 1040 and Schedule C.
In a sole proprietorship, profits and losses of the business are passed through to the owner's individual tax return without being taxed at the company level. A sole proprietor must also pay self-employment tax.
Do Sole Proprietors pay quarterly estimated tax?
Yes. When sole proprietors expect to owe $1,000 or more in taxes for the year, the Internal Revenue Service (IRS) requires them to pay estimated quarterly income tax.
Get help with your taxes
Finding the right accountant has never been easier. In just 5 minutes, we'll get to know you, your business, and the kind of help you're looking for.