Sole Proprietorship Business: Pros and Cons of a Sole Prop

A sole proprietorship is an unincorporated business owned by a single person (the sole proprietor) who must pay their personal income tax based on the income from said business. The government does not highly regulate sole proprietorships, which makes them fairly straightforward to set up and dissolve.

Small businesses fall into one of three categories: a sole proprietorship, a limited liability company (LLC), or a partnership. Here are a few key areas in which they are similar and different:

• Establishment: A sole proprietorship is established the day the company begins doing business—there is no legal paperwork to file. A partnership operates the same way, except participants may want to fill out contracts or agreements between themselves to establish the relationship. An LLC requires the owner or owners to file with their state what are called articles of organization, for which the state may have various requirements to ensure the company earns a business license.
• Liability: If any legal issues arise with a sole proprietorship or partnership, the owner or owners are entirely responsible. An LLC’s business structure offers liability protection for the owners because it’s considered to be a separate legal entity.
• Name: Although you can establish a sole proprietorship or a partnership just by stating it exists, the company’s name will not be legally secured. Some states require the company to file for a fictitious name, or a DBA (Doing Business As), which gives the business owners legal standing for the name. By contrast, an LLC’s business name is established and safeguarded when you file the articles of organization with the state.
• Taxes: The business owner of a sole proprietorship reports their taxes to the Internal Revenue Service (IRS) through their personal tax return, because to the IRS, the business and the person are the same. Partnership owners file the partnership’s annual tax form to inform the IRS of the status of their partnership’s deductions and profits. The partners then file their respective personal taxes, just like the owner of a sole proprietorship would do, but the partnership owners report their income gains or losses based on the partnership’s annual tax form. If an LLC has one owner, then they file their business taxes just like a sole proprietorship; if there are two or more owners, they treat their taxes like a partnership.

A sole proprietorship has no legal requirements for establishment and no liability coverage, so certain businesses tend to lend themselves well to this type of structure, including:

1. 1. Accountants: An accountant can work from their home or an office and does not require an assistant or any employees unless their company grows. They are typically self-employed people, who provide a variety of services to small business owners.
2. 2. Artists: Like other freelancers, artists can work assignment to assignment or in contracted roles. A sole proprietorship can give their business authenticity and legitimize their work.
3. 3. Dog trainers: A sole proprietorship can be an attractive option for a dog training business since it can enable individual trainers to get their business up and running quickly.
4. 4. Landscapers: A landscaping company usually has multiple employees but can also hire day laborers to do jobs on demand. Your landscaping business can potentially be a sole proprietorship if you start the work yourself and then hire people to assist you.
5. 5. Writers: A freelance writer works from assignment to assignment or on contract. A sole proprietorship can allow them the freedom to work for multiple people or companies simultaneously as an independent contractor.

A sole proprietorship can have a few different advantages, particularly if you’re looking to begin a business with minimal paperwork. There are a few other reasons as well:

1. 1. Setup can be easy. Anyone can start a sole proprietorship at any time by taking on their first client or beginning any business activity. Some states require paperwork for specialized licenses and permits (resale licenses, for example) for the new business entity, and you may need or want to file a Doing Business As, or DBA, depending on where the business is located.
2. 2. There can be tax advantages. Since the IRS treats a sole proprietorship and the owner of the business as the same entity, you can file both the taxes for the business and your individual taxes simultaneously each year. Keep in mind that you have to declare any business income or losses with a special form for tax purposes—use Form 1040 or 1040-SR (Schedule C) from the IRS. Social Security and Medicare are handled through self-employment taxes.
3. 3. No special bank accounts are required. The IRS treats the sole proprietorship and the owner as the same entity, so any income derived from the business can funnel through your personal bank account and you don’t have to set up special accounts just for the business unless you want to do so.
4. 4. The owner is in charge. The owner of a sole proprietorship doesn’t have to answer to a board, directors, or anyone else. You can hire as many employees as you want, too.

Drawbacks to a sole proprietorship revolve around its establishment, your risk level, and other factors. Here are disadvantages worth considering:

1. 1. The owner can be liable. If a customer decides to sue or an employee has an accident on the job, as the owner, you are liable for everything. The US government, including the IRS, views you and your business as the same entity, so if something goes wrong, you have personal liability.
2. 2. Getting a business loan can be harder. Even though a sole proprietorship is a business, banks often want to deal with a company that has its own business bank accounts and credit history. That’s difficult to establish for a sole proprietorship owner, who can legally use their own personal bank accounts and personal credit history. If your business plan is to expand through an investment of capital or even just acquire a credit card, it may be better to establish an LLC or corporation instead.
3. 3. The owner wins or loses with the business. Should the company go bankrupt, the owner can be liable for the business debts, and the government could collect personal assets as collateral.
4. 4. You must use your social security number. When forming an LLC, the owner receives an Employer Identification Number, or EIN. If the business operates as an independent contractor, you can use the EIN on tax forms, which adds legitimacy to your venture. A sole proprietorship doesn’t receive an EIN, so you would have to use your social security number, which can be disadvantageous from a privacy standpoint, and doesn’t provide the validity you might receive otherwise.

Creating a sole proprietorship is as simple as taking on a client or selling a product. Beyond that, here are other considerations:

• Pick a business name. The name of the company can be anything you want, assuming it’s not the registered trademark of another business. Select your own name based on what you do or how you do it, or make up a trade name. Depending on the location of the company, you might need to file for a fictitious name, also known as a DBA.
• Develop a business plan. Create a business plan to set goals and put a growth strategy in place so you can set yourself up for success.
• Find an accountant. It’s important to determine how much revenue to put away for taxes and how to manage the books. You should also consider determining your estimated taxes first, so you can decide whether you want to pay taxes quarterly or put away money for your income tax return. An accountant can guide you through either process.
• Check out the SBA. The US Small Business Association, or SBA, has a wealth of information about starting a business, including a sole proprietorship. They have tips on what licenses and permits you might need for your state and any other requirements your local government might require.

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