What is a Sole Proprietorship?

What is a Sole Proprietorship?

Sole proprietorships are very popular among self-employed and single-owner businesses. Here is what you should know. 

Starting a business isn’t easy, but the reward that comes with helping a customer resolve a need with a product or service makes all of that hard work worth it. If this is your first time in the business world, then you’ll need to do a few things. First you’ll have to come up with an idea, a business plan, and decide on a business structure.

The most important of these three is probably the third. 

In this guide, we’ll be going over just one type of business model — the sole proprietorship. There are many types of businesses out there, so if you’ve never heard of a sole proprietorship before, then rest easy because we’ll fill you in. 

Sole Proprietorship Business Definition

A sole proprietorship is an unincorporated business often referred to as a “sole trader” or simply a proprietorship. This legal entity has only one owner that’s required to pay personal income taxes (Form 1040 and Schedule C) on any profits that the business earns. The owner is responsible for paying self-employment taxes. This includes Medicare and Social Security. 

Sole proprietors don’t pay themselves a salary. They also can’t deduct their salary as a business expense. Their pay will be the company’s profits — its sales minus its expenses. Sole proprietors can hire employees and pay a salary, but aren’t able to pay themselves that way. 

Like a limited liability company (LLC), a sole proprietorship is relatively easy to set up. It’s also quite easy to dissolve thanks to a lack of government regulation.

Sole proprietorships are very popular among:

• Sole business owners
• Consultants
• Self-contractors

One thing that proprietorships do is conduct business under their own name. This is a plus since they aren’t required to create a trade name or a separate business. Many proprietorships often end up restructuring themselves into LLCs as they grow. 

Ready to form yours? We can help you form your sole proprietorship.

Advantages and Disadvantages of a Sole Proprietorship

As with any business model, proprietorships have their advantages and disadvantages. Here are a few. 

The Main Advantages of a Sole Proprietorship 

Sole proprietorships have several advantages in addition to the tax and ownership benefits we mentioned above. 

They’re easy to set up

Going off of what we briefly mentioned earlier, sole proprietorships are appealing due to how easy they are to set up. One very important thing to know is that, if you’re a single owner, then your business will automatically be recognized as a sole proprietorship.

In most states, you won’t have to do anything beyond filing your “doing business as” (DBA) requirements, and making sure you have all proper permits and licenses. 

They’re affordable to start

When learning what’s required to start a sole proprietorship, know that there are few costs needed to establish them. As an example, legal costs would be centered around a business license or permit instead of registering the business with the state. The same goes for obtaining a registered agent. 

They’re easy to control 

Sole proprietorships are very appealing because of the freedom of control they offer the owner. As the sole owner, all business decisions are yours to make without having to deal with compromises or interference from other owners. And the cherry on top is that all business profits and benefits are yours. 

They’re not taxed separately 

When it comes to sole proprietorship taxes, they aren’t taxed separately from their owner. When tax season rolls around, all you’ll need to do is report your business’s income and deduct its losses on your personal tax return.

On top of that, the tax rates for a sole proprietorship are typically the lowest of all business models. Also, sole proprietorships aren’t always required to have an employee identification number (EIN), although you can request one if you’d like. 

The Main Disadvantages of a Sole Proprietorship

Like with all good things, sole proprietorships do come with some potential disadvantages. 

They have unlimited liability 

Since your business is not a separate entity, your personal assets might be used to pay off debts or liabilities. For example, if the business is sued or goes under, then your vehicle, home, and other personal assets might be seized to settle any business debts. 

They may NOT qualify for a business bank account

Not having to register a sole proprietorship may sound like a grand deal, but it does come with a caveat. Banks may not recognize the business’s legitimacy without formal documentation, making a business bank account difficult to get. Know that different variables, such as your state, the bank you’re working with, and having an EIN can affect this process. 

They have limited funding options

Since sole proprietorships are sometimes not recognized by financial institutions and investors, then securing business loans will be an uphill battle. 

They can be especially hard to run

Running any type of business is hard, but since you’ll be the only owner of a sole proprietorship, the day-to-day responsibilities and decisions will rest on your shoulders only. This means that you’ll be responsible for all of its successes — and failures. 

When is a Sole Proprietorship Suitable for Me? 

As a business owner, if you’d like to avoid the process that comes with creating most business entities, then consider a sole proprietorship since they’re easy to set up. They’re also a great option if you don’t plan to build the business beyond yourself. 

Just keep in mind that as long as you report your business’s income on your personal income tax return while following the rules when it comes to your quarterly estimated tax payments, then your business will be in good standing. 

Sole proprietorships are also a great option if your business is entirely self-financed. This means using your own saved money to start the business. Like we mentioned earlier, since sole proprietorships often can’t get business loans, you’ll have to rely on credit cards and personal loans. And with high interest rates, this can be very risky. Saving up may be the best thing to do. If you’re unsure of how to get started, then reach out to a licensed professional for help. 

Summary

Hopefully you now have a much better idea of what a sole proprietorship is, how it works, and if you’ll benefit from establishing one. We suggest looking into the topic in further detail and speaking with a professional to help you make the best informed decision.