What is a sole proprietorship?
According to the IRS, a sole proprietorship is an unincorporated business owned by one person. A sole proprietorship is the simplest business structure, representing an individual entrepreneur. The business owner may conduct business under their legal name or register a business name with local authorities. Because a sole proprietorship is the easiest and most affordable, it is common choice for small businesses and independent contractors.
Some examples of sole proprietorships include:
- A freelance writer
- An IT consultant
- A local grocery store
- A small farming business
- An online store owner
All of these individuals operate businesses or offer services to others as self-employed persons. While one individual operates sole proprietorships, they can also hire W-2 employees and independent contractors if they acquire an employer identification number from the IRS. Regarding setup, sole proprietorships are established by offering goods or services to others. Individuals can — and should — register these business activities as a sole proprietorship by simply choosing a business and trade name, as well as any necessary permits or licenses required for the nature of their work (e.g., a real estate license or zoning permit).
While setting up a sole proprietorship is simple and comes with relatively straightforward guidelines for filing taxes, it is only right for some. Depending on your business, an LLC or S-Corp might be a smarter option.
The Top Advantages of a Sole Proprietorship Business
There are numerous advantages to establishing a sole proprietorship — evident in the existence of over 27.8 million non-farm sole proprietorships, as reported in the 2019 Statistics of Income Bulletin by the IRS. For many small business owners and freelancers, a sole proprietorship is a perfect way to register their business activities with few requirements legally. Since sole proprietors are not separate from their businesses, and their business and personal taxes are not independent, the sole proprietorship is the only business type that makes sense for many individuals.
So, what is the advantage of a sole proprietorship? There are numerous positives below.
Easy to establish
One of the benefits of being a sole proprietorship is the simple registration process, which requires minimal paperwork. There is little registration, and your sole proprietorship begins when you start conducting business. Unlike other business types like LLCs and S-Corps, individuals do not need to register sole proprietorships with their states. They must choose and file a business name and obtain any zoning permits or special licenses. Some states may require sole proprietors to obtain independent contractor licenses as well. The main formalities required for single-owned sole proprietors with no employees are to file your income and self-employment taxes accurately.
No corporate income tax payments
Another perk of establishing a sole proprietorship over other business structures is an arduous process that's simpler than for any other business. Sole proprietor taxes are considered "pass-through" taxes, as they’re passed directly from the business to the individual. Thus, filing taxes as a sole proprietor is no different than filing taxes as a self-employed person, reporting your net profits as personal income tax.
To do this, sole proprietors fill out Form 1040 and Schedule C, as well as any other necessary forms. The IRS offers a comprehensive guide on sole proprietorship tax forms, and countless resources exist to guide you through the process. Additionally, sole proprietors may pay quarterly estimated taxes using Form 1040-ES. Plus, these business owners can easily deduct business expenses from their taxable incomes using forms Schedule 1 and Schedule A, including special deductions like health insurance, home office space, mileage, and transportation.
Less expensive than other business models
One of the greatest perks of starting a sole proprietorship is that it’s free to register. The only costs are registering sales and service tax, zoning permits, licenses, and taxes. All other business types must pay yearly fees. There is the risk involved with liability protection.
A sole proprietorship is the only business type that does not require business owners to open an additional bank account. As a sole proprietor is both the income-earning individual and the business owner of their entity, they can operate using only a personal bank account. This is just another example of the simplification that comes with choosing a sole proprietorship.
No limit on how many people you can hire
You can easily hire employees and independent contractors to work for your business as a sole proprietor. To do so, sole proprietors simply obtain an employer identification number from the IRS. They then must provide a W-4 form to employees and a W-9 form to contractors, so they are registered for taxes. They will also likely need worker’s compensation insurance to cover workplace accidents. Even with employees, though, sole proprietors still pay taxes as personal income tax.
Complete control of the business
Having complete control of the business is easy in a sole proprietorship. Unlike other business models, there are fewer requirements involved, such as organization officers.
The sole proprietor has complete access and control on making decisions for the business, the revenue, payroll, and other elements. Because the sole proprietor has complete control on everything that involves the business, there are no concerns regarding various positions that requires parts of the ownership rights and governing decisions regarding the business direction.
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What are the top disadvantages of a Sole Proprietorship?
While sole proprietorships bring numerous benefits, there are also disadvantages to this business type. A sole proprietorship is only suitable for some, and it's necessary to consider the cons to get the full picture.
Unlimited personal liability
The lack of liability protection may be the main disadvantage of establishing a sole proprietorship. As the business and individual are equivalent under a sole proprietorship, the individual is solely liable for any legal and financial issues that arise from the company. Without separation from your business, you could be sued or have personal assets seized if you run into trouble. An LLC might be a better choice for those who desire greater legal protection. An LLC is also an excellent option for small businesses, and it separates the company from the individual owner. However, lower-risk business operations might only need a little legal protection if they file their taxes correctly.
Difficult to raise money
One of the disadvantages of a sole proprietorship is the lack of access to outside capital. Most investors will not invest in sole proprietorships, making acquiring financial assistance more difficult than other business types. Additionally, getting business loans from the bank can be more difficult for a single-member entity. In the eyes of banks and investors, a sole proprietor is not much different from an individual. Thus, they are less likely to give capital to this business type. Sole proprietors may, however, be able to acquire personal loans to assist with their businesses.
Harder to sell your business
Selling your business or transferring it to a successor is nearly impossible as a sole proprietor, as the company is tied directly to the original owner. To sell a sole proprietorship, you have to sell their business assets, such as stock and equipment, to the buyer. Additionally, you may have to establish a Doing Business As (DBA) for your successor to continue operating your business.
Taxes may be higher than other business models
As a sole proprietor, you are individually responsible for accurately filing your taxes on time. You are also responsible for confirming whether you need to pay quarterly estimated taxes, and failing to do so when required can result in penalties. While all business owners have to file taxes or hire an accountant, mistakes fall on the individual as a sole proprietor, and fees come out of their pocket.
Solve the challenges of sole proprietorship with Skuad
Sole proprietorships are only for some, but for many, they are an excellent way to pursue a small business. Skuad helps enterprises manage legal operations and taxation with ease. Get in touch today by scheduling a demo, and discover how Skuad can be the perfect solution for you.
What are the top 7 advantages of a sole proprietorship?
- Easy to set up and get started
- Comparatively lesser paperwork
- Fewer registration fees
- Simplified banking processes
- Simplified business ownership
- Freedom and flexibility
- Simpler income tax
What are the top 3 disadvantages of a sole proprietorship?
- Unlimited liability
- The capacity to raise capital is limited
- Lack of financial control and difficulty in tracking expenses