Sole Proprietorship 101: The Simple Guide to Starting a Business (2023)

Sole proprietorships are not separate entities by law, so it is considered one of the easiest types of business to form.

Unlike a corporation or LLC, you do not have to register with the state. However, you must obtain the appropriate permits and licenses to operate legally, and you are personally liable for any debt, lawsuit, or tax incurred by your business.

Most companies in the United States are sole proprietorships. Many entrepreneurs love sole proprietorships because of the ownership they have over business decisions and revenue. These companies are also easy and inexpensive to set up.

So how do you start a sole proprietorship? Below is a step-by-step guide for you.

However, before starting a business, it is important to have a business plan. Here's an easy-to-use oneBusiness plan templateto start.

Now that you have the tools to create a business plan, let's go through the definition of a sole proprietorship and the types of sole proprietorships one would typically start.

A sole proprietor is a person who has complete control over the revenue and operations of a business. The sole proprietor not only takes home all profits, but is also responsible for all debts, lawsuits, and taxes incurred by his business. If their business is sued, personal assets like their home, credit, and savings are unprotected.

types of sole proprietorships

A sole proprietor can operate as an independent contractor (freelancer), business owner, or franchisee.

  • Independent contractor: An independent contractor is a self-employed sole proprietor who undertakes projects with clients on a contract basis. They are free to choose which customers they take on, but are often subject to the processes and methods that the customer requires.
  • Business owner:Entrepreneurs can also be self-employed sole proprietors. Unlike contractors, there is much more autonomy in performing work for clients. The operation itself can be even more complex with employees and/or intellectual property.

franchisee: Franchisees can also be sole traders. The franchisee benefits from the leadership and business model of a larger brand. In return, royalties are paid to the franchisor.

How to start a sole proprietorship

If you are looking to start a new business from scratch or have a side hustle that you would like to turn into a full-time business, consider registering as a sole proprietorship. Here are some steps you can take to get started.

Step 1: Make sure a sole proprietorship is right for you.

First, is starting a sole proprietorship right for you? Or should you start another type of business?

Choosing the right corporate structure is key to the success of your business. As theSBA points this out, "The business structure you choose affects everything from day-to-day operations to taxes to the risk of your personal wealth."

sole proprietorships, partnerships,Limited Liability Companies (LLCs), corporations and cooperatives are just a few of the ways you can structure your business.

There are also clear differences with regard toLLCs versus S Corps. While sole proprietorships and LLCs are two of the most common corporate structures, there are key differences between them.

Sole proprietorship vs. LLC

A limited liability company (LLC) provides the entrepreneur with liability protection and tax benefits. Meanwhile, sole proprietors bear personal liability for their businesses. Additionally, an LLC can be owned by investors, while a sole proprietorship is usually owned and managed by an individual.

(Video) How to Start a Sole Proprietorship Business / Sole Proprietorship Explained

Once you've determined that a sole proprietorship is right for you and your business, it's time to talk to the experts.

Step 2: Talk to your nearest small business development center.

Before starting your sole proprietorship, consult with your nearestSmall business development center. There you can learn the steps your state, city or county needs to legally operate your business.

Step 3: Choose a name.

Choosing a nameis the fun part – researching whether it's taken and trademarked or not gets tricky. search thatUnited States Patent and Trademark Office(USPTO) to see if your chosen name is trademarked. If not, you should submit your name to the USPTO to get a trademark on it so that no one else can operate under that name.

Step 4: Register your DBA.

As a sole trader, the legal name of your business is your personal name. However, if you want to operate under a different name, say "Global Business Consulting Services," that's what you want to doRegister a fictitious or "business title" name, also called DBA.

In many cases, you need to separate business and personal funds. A DBA is often required when opening a bank account or credit card for your business. Your state may also require follow-up steps after registration.

In most cases, you must publicly post the name under which you do business - and then provide your local government with proof of posting.

A DBA also ensures that no one is doing business under the same name in your country. bottom line? Register your DBA, soon.

Step 5: Buy a domain.

Once you've picked the perfect name, it's time to take care of a domain. For an easy customer experience, your domain name should match your business. Use this to find out whether the desired domain is occupiedICANN Accredited Databases. Even if you're not ready to create the website, reserve or buy your domain name so no one else can.

Step 6: Register for a commercial license.

Individual businesses also need oneBusiness licenseoperate in most cities. Don't skimp here. Fines for operating without a license can be steep. You may also need your business license to open a bank account – but more on that below.

Step 7: Check other permits or licenses.

The fees associated with not having the right licenses or permits can be crippling for a fledgling business. Be sure you got the right onefederal licenses and permitsAndgovernment licenses and permits. This can include:

  • A permit from the Health Department to prepare or serve food
  • A federal permit for the transport of animals
  • A health and safety training course to open a day care center
  • A financial advisor certification exam
  • A building permit to run your business from home
  • Register with the state tax office if you have employees or charge sales tax

Do the legwork ahead of time and figure out what licenses and permits you need. The fees you pay during this process are nothing compared to the fines you may have to pay for not submitting the correct documentation.

Step 8: Get an Employee Identification Number (EIN).

If you operate alone, you may not need an employee EIN and may operate and file taxes under your social security number. However, as soon as you hire an employee or set up a pension plan, you must submit an applicationFederal Employer Identification Number(A). It is free and can be obtained online.

Step 9: Open a business account.

It's important to separate personal and business expenses when you run a sole proprietorship (especially if you're audited).Opening a commercial bank accountensures some protection of your business funds. This account also allows customers to pay with a credit card and write checks to your business. You can also build a good business credit history.

You want to be able to prove to the IRS that you operate your business to make a profit. This means that the losses you suffer in the first few years remain tax deductible.

It is also advisable to build up a good credit history before starting your business. While credit cards can help you in the early days of your business when cash flow is low, the interest rates add up quickly and can easily become overwhelming.

A personal loan is often the better option. However, a good credit rating is a prerequisite for such a loan.

Step 10: Charge Insurance.

Since one of the biggest risks of starting a sole proprietorship is liability, proper insurance is a must.

At a minimum, consider property and liability insurance, auto insurance, health insurance, and disability insurance. This can be expensive, but it ensures that you and your personal assets are protected from lawsuits and professional setbacks should they occur.

Boxthis SBA articleto learn more about the coverage you need.

Step 11: Pay your taxes.

As a sole trader, you willpay income taxon all income from your business networks. File your income taxes for sole proprietorships by usingSchedule Con your form1040. Then add your company's income or losses to the other income you've recorded.

(Video) How to Start A Sole Proprietorship in California - Step by Step Guide To Sole Proprietor

You can use any business losses to offset other sources of income, e.g. B. A salary from your main job or a spouse. But be careful not to go in"hobby shop” Territory with the IRS. You need to prove your business is not a hobby in order to reduce your taxes. When your business becomes profitable, it may be time to apply for or become a businessS Corporation.

Keep in mind that since you're self-employed, your paychecks won't be properly withheld at the time of payout. Instead, you can count on estimated quarterly tax payments. They will then cover the difference or receive a refund for a shortage or tax season overage.

For this reason, you should set aside money from every paycheck to cover those quarterly and yearly expenses.

Advantages of Sole Proprietorship

The main advantage of a sole proprietorship is the freedom and flexibility it offers to the owner. This is especially true for new entrepreneurs and people looking to scale their side hustle.

In any case, the sole proprietorship has many advantages. Here are some general benefits.

1. Full Authority to Make Decisions

As a sole proprietor, you bear full responsibility for decisions and decisions for your business. In contrast to a partnership or a GmbH, you do not have to take the opinions of shareholders or legal partners into account. You are free to take your business in whatever direction you think works best.

2. Easy to set up

A sole proprietorship is much easier to set up than other forms of business.

As a sole proprietor, you do not have to worry about legally valid contracts with other business partners. They also don't have to do other tedious tasks that other companies require, like giving shares to shareholders or electing a board of directors.

However, you must obtain the necessary licenses and permits to legally run your business, such as: B. Sales tax permits and building permits.

The licenses and permits you apply for depend on the type of business you wish to operate. Check with your local or state government to know exactly which ones you need.

3. Lower acquisition costs

Starting a sole proprietorship is mostly free. Of course, you will have to pay to register your business name, obtain your business domain, and obtain any necessary licenses or permits, but you won't pay the average $1,000 cost of forming an LLC.

This is great if you're working on a tight budget as you don't need to invest a lot of money into the business before getting up and running.

4. Simple tax and lower tax rates

Sole proprietorships have fairly simple and straightforward tax requirements compared to other corporations.

In terms of tax returns, sole proprietorships are taxed as transit companies. This means that the company's profits and losses are reported on your personal income tax return. So you don't have to pay separate taxes for your business.

For example, if you use your own home as a business base, you no longer have to pay money for space, utilities and internet. This reduces your personal taxes. You may even get a tax refund when you file your personal tax return.

As a sole proprietorship, you can also benefit from some tax deductions. For example, the Tax Cuts and Jobs Act of 2017 allows sole traders to deduct 20% of their net income from their taxes.

Also, there is no difference between the owner and a sole proprietor. Therefore, the IRS does not require separate accounting records for the company - including balance sheets - as part of its tax returns.

5. Full control over earnings

As a sole trader, you are responsible for all aspects of your business, including revenue. You decide how much you want to pay yourself and contractors (if any). You also choose how much you want to give back to the company.

Disadvantages of sole proprietorships

Like all business models, sole proprietorships also have disadvantages. Here are some of them:

(Video) Sole Proprietorship Taxes Explained - Sherman the CPA

1. Personal assets are at risk

As a sole trader, you are responsible for the financial aspects of your business, including taxes, wages, and legal contingencies. In addition, sole proprietorships do not offer legal protection for your private assets if you get into financial difficulties.

This means if your business is sued or you are forced to declare bankruptcy, the court has the right to seize your personal assets to cover those costs. This includes your savings, home, cars and other items.

Sure, insurance companies can help with this, but they're not foolproof.

2. Difficulties in raising capital

While the initial cost of starting a sole proprietorship is low, raising capital to fund the business can be difficult. That's because banks prefer to support corporations.

Banks consider the sole proprietorship model to be risky, since the private assets of the owner are usually limited and can be used up at any time. Financial institutions are usually reluctant to make loans or make loans to sole proprietors for fear that they will not be able to repay them.

Sole proprietorships may also struggle to attract investors as they are not designed to have shareholders. Without credit and investment, it's harder to take a sole proprietorship to the next level.

3. Self-Employment Tax

As a sole proprietorship, you are required to pay self-employment tax at 15.3% (12.4% Social Security taxes and 2.9% for Medicare) on all income generated by the business.

While Social Security taxes remain constant at 12.9%, the Medicare tax rate increases by 0.9% once you cross certain thresholds. In the long term, this tax can become significant.

4. Perceived lack of professionalism

It is not uncommon for potential investors and clients to view a sole proprietorship as less professional than a corporation or LLC. They may also be wary of doing business with an individual as opposed to a separate legal business entity. You should keep that in mind if necessaryConsider an LLCas an option for your company.

Examples of sole proprietorships

Sole proprietorships are a good choice for people looking to turn their side hustles into something more serious and lucrative. A large number of companies are run as sole proprietorships.

Here are some common examples.

1. Web developer

Web developers design websites for clients using web coding languages ​​such asHTML, CSS, JavaScript, PHP and jQuery. An easier entry into this field would beWordPress web development.

2. Digital Marketer

Digital marketers do everything from managing a brand's social media accounts toImproving a brand's SEO. Make sure you specialize instead of offering all marketing services.

3. Virtual Assistant

Entrepreneurs are busy. You don't want to hire an office assistant, especially since most tasks can be done online. Enter the virtual assistant.

As a sole proprietor running a virtual assistant business, you'll handle chores like bookkeeping and database entry for other business owners.

4. Operator of a day-care center

Daycare operators run small, affordable daycare centers for parents who cannot afford expensive day schools or a dedicated childminder. Background education would be helpful before starting a daycare.

Alternatively, you can also set up a dog daycare center or an old people's daycare center.

5. Freelance graphic designer

Graphic designers create beautiful things: landing pages, brochures, flyers, and social media ads. As with digital marketing, you should specialize in either digital or print graphic design and target specific industries that interest you. Creating a banner for a hair salon would be very different from creating a banner for an engineering company. You also need a graphic design portfolio.

6. IT consultant or computer specialist

Have you ever encountered IT problems? So do countless companies. As an IT consultant running your own business, you would provide IT troubleshooting services to other companies. They also solve problems with the company's hardware and software solutions. Be open to travel for this type of sole proprietorship.

7. Freelance Writer

As a freelance writer with a sole proprietorship, you would target brands that need content written for. This may include non-fiction books, news articles, blog posts, websites, and social media ads. As with digital marketing and graphic design, you should specialize in one form of writing.

8. Freelance Editor

Freelance editors edit the texts of others to achieve clarity, conciseness, and effectiveness. These editors proofread someone else's work for errors. They also focus on the flow and cohesion of ideas.

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You can enter either fiction or non-fiction editing. Alternatively, you can become a copywriter specifically for websites and blogs

9. Freelance editor of non-fiction books

Nonfiction editors typically review highly technical or specialized material for flow, accuracy, and logic. These editors differ from other types in that they specialize solely in manuscript-length works and have an advanced degree in the subject in which they specialize.

10. Fitness Instructor

Fitness coaching is a great choice if you have a passion for fitness. These types of sole proprietors typically target gym goers — or those looking to get started — to help them achieve their fitness goals through a customized program. A degree in exercise science would be an advantage, as would a certification in fitness coaching.

11. Housekeeper

Housekeepers clean houses more thoroughly than a busy homeowner. Duties include mopping, sweeping, taking out trash, washing dishes and doing laundry. For optimal success as a sole trader, you should target your household services to a small geographic area.

12. Landscaper

Landscapers mow lawns, trim bushes, check soil health and do all things back and front yard maintenance. You can offer something simple, such as B. Lawn mowing, and slowly add more services as you gain more advanced knowledge of land maintenance.

13. Caterer

How to cook? Then a sole proprietorship might be right for you. Caterers cook large batches of food for other people's events and usually handle the delivery and setup. Instagram is a great platform to promote your business.

14. Baker

An alternative sole proprietorship for cooking enthusiasts would be a bakery. They can specialize in either sweet or savory, or offer a mix of both. While we often associate bakers with brick-and-mortar bakeries, you can run this business from home and arrange local pickups.

15. Accountant

As a freelance accountant, you would work with small business owners and audit their inflows and outflows. Make sure you master at least one accounting software like QuickBooks or FreshBooks.

16. Accountant

Tax advisors target individuals who find tax return documents inaccessible and difficult to complete. This is one of the easiest sole proprietorships to start as there are no educational requirements. A tax preparation course is all you need.

17. Document assistant

Document support is similar to tax preparation. They would help individuals fill out highly complicated forms - such as B. Immigration applications, visa applications and unemployment benefits applications. You can also submit them on behalf of your client.

Knowledge of another language would be an advantage as those who need assistance usually do not speak English.

18. Resume and cover letter writers

Resume and cover letter writers serve those who have a diverse collection of job descriptions, roles, and skills. They then turn the information into an effective resume. A written background would be beneficial if planning to start this type of sole proprietorship.

19. Event Planner

As a sole trader with an event planning company, you would handle all facets of the event planning process. This includes finding a venue, caterer, decorator, DJ and event furniture suppliers. As a rule, you also take on part of the event set-up. A particularly lucrative specialization is wedding planning.

20. Photographer

Freelance photographers take photos and video of just about anything clients want to capture. As with most of the business types on this list, you should specialize. A corporate photographer photographs the employees of a company. A wedding photographer takes an artistic approach to photographing a wedding. A maternity photographer takes maternity pictures. These three require different skills, so choose the one that best suits your background.

21. Standardized Test Teacher

As a standardized tests tutor, you would coach high school and college students to improve their scores on the SAT, ACT, GRE, GMAT, or LSAT standardized tests. You should specialize in one or two tests.

Make sure you advertise the high score you got on your website. An educational background would be helpful.

22. Translator

You can start a translation business if you have advanced or native proficiency in a language other than English. Businesses, churches and schools need translators to communicate with non-English speaking clients or groups. You can start this type of business without a degree, but certification would be beneficial.

Position your new sole proprietorship for success

Starting a business as a sole proprietor is one of the biggest decisions you will ever make. As great as the risk is, so is the reward. The best part is that you can start it yourself without leasing a building, hiring others, or requiring expensive training. With the steps outlined in this post, you will build a strong foundation to ensure lasting success.

Editor's Note: This post was originally published in September 2018 and has been updated for completeness.


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