Operating as a sole proprietor, consisting of one person, usually involves low stakes, and it’s often on the low-end of the profit margin. Sole proprietors can come from different professions and include independent contractors, freelancers, tutors or teachers, and artists of various kinds. Below we will look at what a sole proprietorship is and how it works, as well as the advantages and disadvantages when operating as one.
What Is A Sole Proprietor?
A sole proprietorship is a business entity defined as informal and unincorporated, the owner takes full responsibility for profits, debts, and potential risks in the business. The owner is considered ‘self-employed’ and will start as a hobby or small business endeavor with their immediate community of friends or family as customers. There are usually no fees or filings required to start.
Sole Proprietorship and Tax
Pass-through taxation will apply to a sole proprietorship as any profits or losses will reflect on the owner’s personal tax returns; personal assets are not legally separated from the business assets. The owner will also need to pay income tax and self-employment tax each year, including quarterly payments when there will be more than $1000 due for the year.
Sole Proprietorship and DBA (Doing Business As)
All payments and documents that require a signature will be done under the owner’s name, this includes contracts, checks, lease agreements, or any other legal paperwork. A sole proprietorship will usually have the owner’s surname as the business name, however, if the owner wishes to use another name, or assumed name, they can register for a DBA (‘doing business as’).
Registering a DBA name (depending on the state) will allow the owner to open a business bank account and all business-related work and documents will fall under their assumed name, which will also offer more privacy as the owner won’t need to use their surname and be as visible to the public.
Sole Proprietorship and Employees
A sole proprietor who hires employees or files excise or pension plan tax returns will need to apply for an EIN (Employer Identification Number) – when this occurs it is recommended that the owner considers forming an LLC (Limited Liability Company). An LLC will facilitate further business growth and include liability protection, especially when there are employees.
Advantages of Sole Proprietorship
The primary advantage of a sole proprietorship business is the ease of starting as it requires minimal costs and effort; the owner can start operating under their name. This is useful if the owner wants to try a new business venture that requires little or no responsibility, in case the business does not work.
Disadvantages of Sole Proprietorship
The disadvantages of operating as a sole proprietor include more risk, in the long run, less privacy, no liability protection, and no tax benefits. Let’s take a look at these in more detail:
More Risk – No Liability Protection
There is no personal liability protection when operating as a sole proprietor, all personal assets (bank account, vehicle, house) will be affected in the event of debts that need to be paid or if the business is sued. As the business grows and earns more profit, there will also be increased risk, and without the proper legal protection, the owner has a higher chance of being impacted personally.
If the owner does not operate under a DBA name they will need to conduct all business and brand marketing under their surname, this includes banking, receiving and making payments, and marketing the business to the public.
No Tax Benefits
Sole proprietors will also need to pay taxes on all profits earned as well as FICA (Federal Insurance Contributions Act), which includes Social Security and Medicare tax.
You can visit TRUiC’s website for more information about operating as a sole proprietorship business, including what to do to make the shift to form an LLC.
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