Everything You Should Know About Setting Up a Sole Proprietorship
If you want to start your own business, you should consider a sole proprietorship. It’s easier to start than other types of businesses and you have complete control. Plus, there isn’t a lot of regulation paperwork or heavy accounting to handle.
We’ve created a guide to explore this type of business structure and explain how to start a sole proprietorship.
What is a sole proprietorship?
A sole proprietorship is an unincorporated business operating by one person. It is not a separate legal entity. However, that doesn’t limit you in the type of business you operate or whether you can bring on employees. It does mean you have a different set of rules and regulations you must follow to maintain government compliance.
Most of these rules relate to taxes but can also relate to safety, local ordinances, and other types of regulations.
Different types of sole proprietorships
There are five basic types of sole proprietorships and they can be a part of any industry. The thing that makes them different from other types of businesses, like limited liability companies, is that most do all the work themselves with no permanent employees.
A common element in most of these types, with the exception of franchisers, is that sole proprietors are often gig workers. That means they work on individual projects rather than a long-standing job. Once the project or event is done, they move on to the next gig.
Some examples of this include construction work, farm crop harvesting, musicians, event coordinators, graphic artists, or copywriters.
Below are the five types of sole proprietors. Some of these categories may also overlap and these types of business owners can work in several ways.
These are people who started a company working in a specific field. It can be someone who set up a handyman services company or a food truck. They have all the licensing and certifications to do the work and own the company.
These are people who take on projects individually, although they may work regularly for a company. Work is done based on time, ability, and project interest. This can be in any field but tends to be used more in professional creative fields like graphic or website design.
Workers that go to work as independent contractors are not officially employed by a company so they are responsible for their own taxes and reporting to the IRS. They also typically aren’t covered by the company’s liability insurance even if they are injured at a worksite.
Those that tend to use this category are musicians, servers, and other event workers.
Subcontractors are hired under the umbrella of contractors for a job. A subcontractor may be covered by the general contractor’s liability and could have taxes taken out of his pay by the general contractor.
In some cases where the subcontractor has employees or independent contractors under him or her, that sole proprietor is given one check by the general contractor and is responsible for distributing pay among his or her workers.
Construction is one industry where this is highly used.
Franchisers are those who bought into a known brand to start their independent business. Many of these are work-from-home jobs like selling Norwex, Mary Kay cosmetics, or natural supplements.
Who should form a sole proprietorship?
Those who should form a sole proprietorship are people who want to run their own business with no or few others involved, want to limit startup expenses, avoid complicated governmental taxation and detailed regulations, and aren’t planning a major expansion anytime soon.
Sole proprietorship owners often have full-time jobs and run their business entity as a side business at first. Those who maintain a permanent job while starting their sole prop business tend to do well at their side business since they can take longer to research and move more slowly into growth.
Advantages of a sole proprietorship
There are three distinct advantages to starting a sole proprietorship. They include the following:
No complicated taxes
A sole prop business allows you to keep all the money you earn outside of paying for your expenses so you don’t need detailed spending reports or tracking. Profits are reported on your personal income taxes, specifically on a Schedule C, so you don’t need complicated forms during tax time. The business itself does not file an income tax return. You can choose to pay estimated taxes quarterly if it’s easier.
You do need to maintain records of expenses for tax write-offs.
No employee hassles
Sole prop businesses typically have a sole owner. You won’t need to go through all the hassle of hiring and firing. You don’t need an employee handbook and won’t deal with the Department of Labor, OSHA, or any other employee regulatory agency.
It can be a test run
Starting a sole prop business is a great way to give your new business idea a test run on the marketplace to see if there is genuine interest. You can keep your regular job while you invest time into your sole prop business so the financial risk is limited. You can grow your sole prop at a slow pace and move into it full-time when you are comfortable with its success.
Disadvantages of a sole proprietorship
Sole prop businesses have some disadvantages that increase financial and liability risk. These should be considered carefully.
You are liable
A sole prop business and your own name are synonymous in terms of personal liability. That means someone can legally sue you personally for work, injury, or a contract dispute. That could put your financial future in jeopardy and also put your personal assets like your home and vehicles at risk.
You are also personally responsible for all of the business’s debts.
You are limited
Sole prop businesses are organically limited because you don’t have permanent employees you can depend on. That means you can’t take on a big construction job or a huge event. This also means you could miss out on some moneymaking opportunities.
Steps to setting up a sole proprietorship
Each state sets up its own rules for starting a sole proprietorship so the first thing you must do is research the rules for your state. You must also spend some time looking at regulations for your local municipality as it can have more stringent rules than the state.
Local governments also control things like zoning for home businesses, permitting for certain types of businesses and local property taxes.
Here are the basic steps for starting your own sole proprietorship.
- Develop your business idea. Investigate both the marketability and regulations applied to that industry.
- Choose a name and, if required by the state, register it. Look in your state’s business registry to see if your proposed business name is taken or for keywords you want to use in a name.
- Set up the foundational elements of your business. This means creating a business plan, how you will get and deliver products, a marketing strategy, and a financing budget. You may want to research various options for financing a business. You need to figure out how much this business will cost you in the first year even if there are no sales.
- Begin implementing your business plan. Get suppliers on board and set a timetable for a formal launch. Get your website ready to publish. Buy business cards. Start marketing locally about your business launch. Start networking.
- Get all your required business licenses and certifications. Many states don’t require business licenses but local cities do.
- Buy liability insurance. This is important for any business.
- Have a plan ready for gaining employees if you think you may need them. Some sole prop businesses may need extra people one day to pack boxes or to work an event. Figure out how you will easily manage those days.
- Launch your business. This can be low-key by an online event or a grand opening at the local chamber. The key is to start selling your products or services.
What resources are available to provide further assistance?
A ton of resources exist for those interested in starting a sole prop business no matter where you live. The federal and state government offers a lot of guidance on the subject. Local cities and counties also have chamber of commerce organizations, small business development centers, and even mentors you can access.
Here’s a look at what’s available.
- The U.S. Small Business Administration has info, guidelines, and advice for those wanting a sole prop business. It also offers links for various funding options, including business loans and lender options.
- The Secretary of State’s office in your home state will tell you the state rules for starting a sole prop and also has ways to search for business names. It may also include state funding sources and other resources.
- Small Business Development Centers has a wealth of resources available to entrepreneurs as well as educational courses. Some SBDCs have incubators that include meeting and office space, mentors and hand-on help with business plans, marketing and other things.
- Chambers of Commerce in local cities can provide some of the best resources for networking within your community. That can help you identify local vendors and suppliers you may need. The chamber is also a willing cheerleader for members when they do a business launch and can provide other assets like meeting rooms.
- SCORE has volunteers who offer free business consulting and advising for a number of business decisions from creating business plans to finding funding.
What are the key features of a sole prop business?
A sole prop business is owned by a single person who controls the company. That person is identified as the business and assumes all liability as well as all profits. The business can have its own name, known as a trade name of a fictitious business name, but it is not a separate entity.
Can a sole prop business have employees?
Yes, a sole prop business can have employees but doesn’t have permanent employees. Employees of a sole prop business are independent contractors, subcontractors, or gig workers. They are given a 1099 form at the end of the year
Are sole props taxed differently than individuals?
Sole prop businesses aren’t taxed by the federal government. All profits are reported on the small business owner’s IRS personal tax forms, along with any write-offs.
Can a sole prop business become another form of business later?
A sole prop business can change its entity formation at any time. It can take on a partner, or become an LLC or an S-corp as long as the proper paperwork is filed with the state and federal government. You will need a government federal employment identification number (EIN) to hire permanent employees.
Can a sole prop be sued?
Legally, a sole prop can’t be sued because it doesn’t exist on its own. However, the business owner can be sued because they and the business are one. Those suing may still include the sole prop name on the case file if it’s different from the owner’s name to hold legal ground.
Can you make a lot of money with a sole prop?
It depends on the business, the owner, marketing, and many other factors. Some sole props do well. ZipRecruiter reports a range of sole prop salaries between $21,000 and $82,000. The average business income for most ranges between $39,500 and $51,500 in the U.S.
Is it easy to start a sole prop?
A sole prop is the easiest business type to start. Sole props have virtually no paperwork as LLCs, partnerships, and S-corps do. Many don’t even require an accountant or separate bank accounts since there are no business taxes, all taxes are reported on personal taxes. Most states don’t regulate sole props either.
How do sole props pay themselves?
A sole prop owner doesn’t earn a weekly paycheck but you can set it up to draw out money weekly for budgeting. In the end, all profits are reported to the IRS through your personal tax return whether you spend them or leave them in a separate account.
Should I have a business account for my sole prop business?
It isn’t legally required to have a separate business account for a sole prop. Since you and the sole prop are one, you can put all money into your personal account. However, it may serve you to have a separate account for budgeting and accounting purposes. A separate account under a business name also establishes credibility with customers.
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