Business Entity: What is a Sole Proprietorship?

October 14, 2020
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There are so many different tasks and questions that go into starting a small business. It may feel like there are a million moving pieces, and you’ve got to stay informed and in control of all of them. 

When you’re feeling overwhelmed, what you need most is clarity. What’s the focus of your business? What will you do with your business, and how? To answer these questions, you need to address the fundamental question of business structure. What is the best kind of entity for your small business to be?

Your “business entity” refers to the legal status of your business. It shapes your business’s organization and determines how the U.S. federal and state government will recognize your business. If you are planning to start a small business, there’s a good chance you’re hoping to create a sole proprietorship.

What is a Sole Proprietorship?

A sole proprietorship refers to any business with a single owner. If you own a small business and have all the authority over what happens to your company and how to run it, you are the sole proprietor of that business. 

Sole proprietorships are the most common of all businesses. Many people who are self-employed or who primarily work as a contractor run a small sole proprietorship without realizing it.  

It’s the question of ownership that sets these small businesses apart from other business entities. Partnerships split ownership between two or more people, and corporations are owned by their stockholders and run by their boards. Sole proprietorships, meanwhile, are relatively simple. There might be many employees, but they are owned and primarily operated by one individual alone. 

How to Form a Sole Proprietorship

Unlike many business types, you do not need to register a sole proprietorship with the federal or state governments. That means it’s a lot cheaper to form, as you don’t need to pay any incorporation fees. As far as tax law is concerned, you and your business are not separate entities. Your business income is your personal income. 

Starting a sole proprietor business is as simple as picking a name and setting up shop. However, there may be licensing requirements depending on your location and what you plan to do as a business. Here are the key steps to follow in setting up your business:

  • Pick your official name and business address.
  • Connect with your city or local government to file for a license and check for other legal requirements.
  • Register with the state if you’re going to be selling taxable goods or services.
  • Request an employer identification number from the IRS if you’re going to hire employees. 

Difference Between Sole Proprietorship and LLC

The other common business entity choice for new small businesses is the limited liability company or LLC. The differences between a sole proprietorship and an LLC can be complicated but very consequential, so you should take your time with this decision and consult with an attorney and accountant if possible. 

The primary difference between these two entities is clear from their titles. An LLC exists as a corporate entity separate from its owners, which limits your liability. You could lose your investment, but you will not end up responsible for an LLC’s debts, whereas you do hold full liability for whatever happens to your sole proprietorship. 

Starting an LLC is also far more complex and expensive than starting a sole proprietorship. It requires putting together an operation agreement with all other “members” or partners working with you. 

Pros and Cons of a Sole Proprietorship

One of the most significant benefits of making your business a sole proprietorship is simplicity. It’s relatively quick and inexpensive to start your business officially. You can also avoid the bureaucracy and negotiation of corporate ownership. Whatever you want to do with your business, the power is in your hands to decide and make it happen. 

It’ll also be simpler to file your tax return with a sole proprietorship. You don’t have to file anything extra for your business outside of your personal return. It would be best if you still were sure to keep a record of your expenses and income so that you claim corresponding business deductions on your tax return

The most obvious downside of a sole proprietorship is the liability. The business doesn’t exist apart from you as an individual, so if your business goes into debt, you go into debt. If someone sues your business, they’re suing you directly. LLCs and other corporation types give you some degree of protection from financial and legal risk. 

Taking Your Choices Seriously

Whichever business entity you decide is most appropriate for your company’s vision, you hope to realize, make sure you’re confident before you move forward to the next step. When you’re putting your money and effort on the line for something you’re passionate about, you have to know precisely what you’re working toward. 

Take your time with this decision and consult professionals that can help you assess your resources and opportunities. Hire an accountant to work with you on your business plan and maximize your chances of success. 

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.