Sole proprietorships, or sole props, are the simplest and most common types of business in the world, especially in the United States. Business owners and aspiring entrepreneurs prefer to start as sole props as they are the easiest to form and dissolve.
By default, your business will be a sole prop entity. However, you must do your homework to determine whether this is the right fit for you and your company.
If you are a sole prop owner or new to the business market, read this article to find out all about sole proprietorships, how it benefits you, what shortcomings it might have, and how to set it up for your business.
A sole proprietorship is exactly what it means: a business with only one owner. In this type of business, the individual owner pays personal income tax on the profits they make from the business.
As a sole proprietor, you are responsible for all matters related to the business, such as liabilities, debts, lawsuits, and more. This also includes personal appearances in the court, being answerable to the Internal Revenue Service (IRS), and so on.
Everything to know about k1 form is to report each partner's share of the partnership's earnings, losses, deductions, and credits. It serves a similar purpose for tax reporting as one of the various Forms 1099
Taxes for sole proprietors work like individual taxes, even if they have registered a separate business name. The business income is treated as personal income, and tax is deducted from the profits.
This is beneficial because the tax rates are equal to personal cases and can thus be lower than corporate rates. All business tax forms are filed with IRS Form 1040 Schedule C.
If the tax amount exceeds $1,000, the owner must pay estimated taxes quarterly or as applicable.
Sole proprietors are also treated as self-employed individuals. Hence, they are subject to self-employment taxes, which include social security and healthcare. The self-employment tax is charged at 15.3% of the net income.
Consider the following before you start your business as a sole proprietorship:
Setting up a sole proprietorship business is surprisingly easy. As soon as you offer a product or service and charge financial compensation for it, it can be considered a business. And unless you file for different paperwork, your business is a sole prop.
However, you should know some terms and conditions that qualify your business as a sole prop:
Any hobby or one-off service cannot be considered a sole proprietorship. For the IRS to recognize your company legitimately, you need to profit from the business.
Let's assume that you sell lemonade to people by the park and ask for donations rather than charging a fixed price. Chances are you'd make barely enough to cover the costs of the business.
In this case, the IRS would consider your lemonade counter to be more of a social service rather than a business. To be qualified as a sole prop, you need to make significant profits and consistently carry on the business activity.
A business needs certain permits and licenses to operate legally, depending on the state and industry. Explore the Small Business Association’s Business License and Permits to check which permits are required by your business.
For a sole proprietorship, all the permits come with the owner’s name and personal information on them. To get your business name featured, you must file a “doing business as” form. Plus, you need an employer identification number to hire employees.
Although not a government mandate, using a business account for company-related transactions can make your life much easier while filing taxes.
You can also get a business credit card, business tax track your expenses separately, and ensure clean bookkeeping with a separate account. This is also highly useful if you run multiple businesses.
Ideally, you can run any business as a sole proprietorship, but certain types of businesses are better suited to this structure. They need a lower initial investment and don't need investors or loan liability protection.
Some common sole prop businesses include:
Owning a sole proprietorship certainly gives you an upper hand in more ways than one. Let's look at a few key benefits:
Since you are the only owner of the business, you can control it as you please. All its income would come to you, just as all its debts would. But since you will be in charge of all business decisions, you can steer the ship away from troubled waters as and when needed.
A sole prop requires less investment as it operates under your own name. You can escape tons of tax liabilities, permit fees, and such. Of all the business structures, this is the easiest and quickest to form.
You can file all business taxes as an individual. The only form needed for this kind of business is the 1040 Schedule C. It is simple to fill out, file, and keep track of if you open a separate account for business-related expenses.
A sole prop requires the least amount of paperwork to maintain. You only need to keep a simple record of business operations and profits.
All other corporations - be it C corps, S corps, or partnerships - have tons of regulations to follow, paperwork to maintain, and red tape to overcome. In contrast, a sole prop is free of these issues and can operate with a lot less stress and formalities.
Now that you understand the advantages, let us list a few drawbacks of sole proprietorships:
There are two sides to being the sole owner of a business. With all its profits, all the debts come to you as well.
You will be personally responsible for all laws your business might violate and any money it may owe. You can also be personally sued for any customer issues or malpractices, even if any employee is responsible.
Your business cannot be deemed as secure in the long run. As the sole proprietor, you may be plagued by certain personal and professional issues that may impact your business. You can also find it difficult to transfer ownership to someone else if you want to opt out.
If you are a new businessperson, your lack of knowledge or experience about the field can harm your venture. Having an advisory board or consultants can save you from such risks or events.
If you need a loan or a big investment to keep your company afloat, it might be challenging for you to secure a loan from banks. Generally, banks and financial organizations prefer to invest in corporations rather than sole proprietorships to ensure better security for their money.
Also understand the working principle of LLC taxes which give business owners significantly greater federal income tax flexibility than a sole proprietorship, partnership and other popular forms of business organization.
Sole proprietorships are perfect for small business owners who prefer to work independently and without any additional liabilities. If run properly, such a business can make huge profits and turn out to be generational and future-proof.
But becoming a sole proprietor doesn't mean you have to manage your bookkeeping all by yourself. Fincent makes tracking business expenses easier so you can focus on growing your business. Find out how our services are designed with creative small businesses in mind.
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