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ComplianceSeptember 24, 2021

What is a sole proprietorship and how to start one

When starting a business, a sole proprietorship is the simplest structure to choose from. A sole proprietorship is a non-registered, unincorporated business run solely by one individual with no distinction between the business and the owner. This has its benefits and drawbacks. For example, as a sole proprietor, you are entitled to all profits, but you’re also responsible for all the business’s debts, losses, and liabilities.

A sole proprietorship is a common business structure in the United States. In fact, BizFilings’ small business survey found that 59% of small business owners reportedly operate as a sole proprietorship.

If you’re wondering whether you should start your business as a sole proprietorship, here’s what you need to know to make the decision.

How to start a sole proprietorship

A sole proprietorship is easy to establish. You don’t need to take any legal steps to form this type of business. If you are the only owner and begin conducting business, you automatically become a sole proprietorship. There is no need to formally file paperwork or submit anything at the federal, state, or local level to be recognized as such.

It is important to note, that depending upon where you run your business and what kind of business it is, you may also need to file for business and/or occupancy licenses and permits.

Advantages of a sole proprietorship

Minimal paperwork and low set-up costs are two major benefits of having a sole proprietorship. In addition, there is the ease of maintaining it. In fact, according to the SBA, it’s the simplest and least expensive business type you can establish.

Let’s take a look at a few additional key advantages.

Taxes: You don’t need to separate taxes for your business. Any profit you make is simply treated as your own income.

But, there are two important tax details to consider as a sole proprietorship:

  • You will still be taxed for all the profits of your business, whether you withdraw the money or not.
  • You need to fill out a Schedule C report, which details your profits and losses, along with a Schedule SE, which refers to your self-employment taxes.

These are both submitted with your personal 1040 income tax return at tax time.

Maintenance: A sole proprietorship is easier to start and maintain than a registered business. With minimal legal costs and no ongoing state requirements, you can simply run your business. This is the case even if you’re using a fictitious name, also called a DBA (doing business as).

Control: The sole proprietor has complete control and decision-making power over the business. Without any partners, you are the sole owner of the business, and can therefore run it as you choose.

Disadvantages of a sole proprietorship

There are a few disadvantages to consider as a sole proprietor. Before choosing the best business structure for your business, consider these potential drawbacks.

Liability: An important fact with this business structure is that the owner is left liable for all obligations of the business — including debt and lawsuits. There is no separation between the assets of the owner and the assets of the business.

Funding: Raising money is a challenge for sole proprietors because it’s not possible to sell stock in the business, which may make investors hesitate to invest. Lending from banks can also be challenging because, if the business fails, all the responsibility falls on the shoulders of the owner to repay the loans.

Long-Term Survival: A sole proprietorship rarely survives if the owner dies or is incapacitated. While a corporation is legally a separate entity from its owners and can be taken over by someone else, a sole proprietorship must be run by its owner.

Lack of Support: While having complete control is a benefit, the sole proprietor alone is responsible for the successes and failures of the business, which can add an extra layer of pressure and stress.

Should I switch from a sole proprietorship to an LLC or corporation?

First and foremost, focus on the needs of your business when deciding between an LLC, a corporation, and a sole proprietorship. If you’re new to being an entrepreneur — for example, you’re a freelancer just starting to find clients — a sole proprietorship is an easy and cost-effective option. On the other hand, a fast-growing business that needs funding would be better suited to forming either as a corporation or a limited liability company (LLC).

Consider your business needs and objectives when reviewing your options, from financial to operational, to make the best choice for you and your business.

For more information, see Single-member LLC vs. sole proprietorship: Advantages & disadvantages.

To learn more about what’s on the minds of other small business owners, check out the BizFilings small business survey 2021: Motivations & challenges for business owners.

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