Sole proprietorships are the most common business structure in the US. This is probably because many people involved in a money-making venture don’t take any affirmative steps when starting their business and sole proprietorship is the default. This article will explain what a sole proprietorship is, how it’s created & taxed, some advantages & disadvantages, whether you need an attorney, and when you know it’s time to move on to a more formal business structure.
What is a sole proprietorship?
A sole proprietorship is a business structure available only to individual owners of a “business”. I put “business” in quotes, because it doesn’t matter if you intentionally set out to start a business or if you just happened to start making money from a hobby, you have a business-even if you don’t think of it that way. The business is not considered a separate entity from the individual. Any time you’re making money off actions you are taking (without taking any other steps), you are considered a sole proprietor.
How is a sole proprietorship created?
A sole proprietorship is essentially automatic if you are in business by yourself. Basically, if you are making money off your efforts, and you haven’t taken steps to form a separate entity-you’re a sole proprietor. No other affirmative action is required to create a sole proprietorship. There are usually no filings, contracts, or any other documents required.
That being said, if you’re doing business in anything other than your name, a “Doing Business As”/DBA is generally required. Filing requirements vary from state to state. In some states, it’s done at the state level, and in others, it’s done at the county level-sometimes filing with the state and county are required. The length of a DBA also varies from state to state.
What are advantages of a sole proprietorship?
- Very easy to setup, because there is literally nothing you have to do (to create the business-there’s plenty you have to do to make the business successful!
- You have full control of management and operation of the business. You don’t have to hold official meetings for the business, keep minutes.
- No annual filing requirements or fees to maintain business
- Taxes are relatively easy, because everything is reported on your Schedule C. Taxes are rarely what most would consider easy, but with sole proprietorship no additional returns are required.
- Really easy to change to another business structure later if you need to. If you outgrow being a sole proprietor, you can easily switch to another business structure.
What are the disadvantages of a sole proprietorship?
- No liability protection for your personal assets. This is a BIG disadvantage. Some businesses are more prone to liability issues, but you should give this disadvantage a lot of thought. You can still get insurance to somewhat protect yourself, but as a sole proprietor all of your assets are subject to unlimited liability if something goes wrong in your business.
- Some people may not take your business as seriously. Whether it should or not, having the letters “LLC” or “Inc.” gives more credit to your business than if you are just doing business in your own name. (“Doing Business As” may be another story, because most people won’t even notice that your business name doesn’t have the extra letters at the end).
- Dissolves automatically if you stop doing business or die. On the one hand, dissolving automatically if you stop doing business is an advantage in my opinion. You decide you don’t want to run the business anymore, you just stop. You don’t have to file any paperwork with the state or take any other action, the business just ceases. On the other hand, for a lot of business owners, they like the idea of their business living on even after they pass. They’ve worked hard to create something and may want to leave the business to their children-with a sole proprietorship, this isn’t possible.
- Generally limited to your own capital contributions and/or bank loans in your own name. Very unlikely to get investors as a sole proprietor. Depending on the type of business you have, this may or may not be an issue. If you are going to need access to capital, most investors won’t touch a sole proprietorship.
How is a sole proprietorship taxed?
A sole proprietorship is taxed at the individual combines with that and you’ll be taxed accordingly-usually in a higher tax bracket. On the other hand, all business deductions are also reported on your individual tax return. So ,those can offset not only your business income, but your other income as well (this is generally the same as a single member LLC).
Do I need a separate account for a sole proprietorship?
In short, yes. It’s not required, but it’s always wise to keep business assets and expenses separate from personal assets and expenses. Having separate accounts makes it easier to keep track of income and deductions for tax purposes. It also makes it easier to see if the business is doing well or not when you keep everything separate.
Do I need an attorney?
Probably not. I will always suggest seeking the advice of an attorney licensed to practice in your state. There are a lot of things to think about when starting a business and a good business attorney can help you think through potential issues you may encounter. However, since a sole proprietorship is the default business structure for single business owners, once you start making money you’re a sole proprietor, so an attorney is not needed to create your business structure. Filing a DBA is also usually pretty straightforward and something most business owners can do by themselves.
Is this a good business entity?
This is a question I get asked a lot. While everyone’s situation is going to be different, it’s possible to run a successful business as a sole proprietorship indefinitely. Other business structures allow for adding other owners, getting investors, and creating a company that can exist without you. But, there is no limit to the amount of money you can make as a sole proprietor.
If you’re a business owner, or thinking of starting a business, you’ve probably wondered what exactly it means to be a sole proprietor and whether it is an appropriate business structure for your business. In this article, you learned exactly what it means to be a sole proprietor and some ways to determine whether it is the right structure for you.
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