What Is a Sole Proprietorship – a 101 Guide for Small Businesses

October 5, 2020

Also known as a sole trader, proprietorship, or individual entrepreneurship, the sole proprietorship is the most common and simplest business structure. If you’re wondering what is a sole proprietorship, and what sole proprietorship means, the truth is you might be running one without even knowing it. We’ve provided you with all the answers to help you find out all the pros and cons of this kind of enterprise, what to do if your venture starts growing and how to avoid the most common mistakes business owners make.

Although one person usually runs it, a sole trader can include more employees. As long as you’re the one and only owner, your enterprise is determined as a sole proprietorship. Let’s clarify the meaning of sole proprietorship and find out more details about this business entity type.

What Is a Sole Proprietorship Business?

The definition of the sole proprietorship is that it’s the simplest form of business, and is not a legal entity. It is an incorporated enterprise owned and run by one person with no legal distinction between the owner and the firm. If you’re the proprietor, it means you’re entitled to all profits and personally responsible for your business’s debts, liabilities, or losses. If you wish to conduct your undertaking under an assumed name, there’s a possibility to register a DBA name (“doing business as”) for your enterprise. It provides you with benefits such as opening a bank account for a firm and receiving payments under this fictitious name.

The sole trade is widespread due to its nominal cost and ease of setup, simplicity, and a lack of government involvement. Still, many individual entrepreneurs decide to restructure their way of operating, as time passes and the company grows, ending up as different legal structures.

What Are Other Business Entity Types Besides Sole Proprietorships

When starting a business, one of the first things should be to choose a business entity type or, simply put, your company’s structure.It’s good to know other business models that can replace your individual entrepreneurship.

There are five most common options in addition to an individual undertaking:

  • General partnership – an unincorporated enterprise with two or more proprietors
  • Limited partnership – registered enterprise composed of active, general partners and passive, limited partners.
  • Limited liability company (LLC) – a registered enterprise with limited liability for all members.
  • C-corporation – incorporated enterprise composed of directors, shareholders, and officers
  • S-corporation – incorporated enterprise taxed as a pass-through entity.

Types of Business Licences You Might Need as Individual Entrepreneur

Even though there are no complicated start-up requirements for establishing an individual undertaking, there may be permit laws, local registration, or license to comply with in order to make your enterprise legitimate. Depending on the state you live and operate in, it’s possible to form a sole trade without a special license. To find out what you need to start as an individual entrepreneur in your state, check out this website and find all the specifics and information you are looking for.

If you want to perform your operations legally, you may need a wide variety of licenses or permits. To mention the most important ones:

  • Operating licenses – if you’re involved in activities being regulated by the government, you must obtain this license from the city or county you’re working in. This license is a must-have if you possess a taxpayer identification number.
  • Occupational licenses – if you’re undertaking is related to a specific trade or profession, you should get this license. With it, you acquire the legal authority to provide a particular service (dietitians, childcare, massage trainers, tattoo shops, etc.)
  • Federal licenses – if your enterprise has any connections with federal sectors, you will be required to obtain it. Federally regulated services are investment advising, ground transportation, manufacturing firearms, etc.
  • Local licenses – these are the easiest to obtain, have the smallest fees, and most businesses should get them.
  • State licenses – some businesses that are required to comply with state regulations (restaurants) need these licenses. If you’re selling services or products that are state-regulated, you also should acquire a state license.
  • Permits – the most common are a DBA, permits from the health department (if your enterprise is food-related), land and zoning permits (in case of a home-based enterprise), fire permits (when dealing with flammable materials), or environmental permits (if your undertaking is environmentally risky).

What Is the Difference Between an Individual Firm and an LLC

As we said before, you might be a sole proprietor not knowing that. Also, a sole proprietor has to be one person, while individuals are not necessarily sole proprietors. It means that individuals are not always business owners. From a liability perspective, there’s no difference between the individual and the business when undertaking as a sole proprietor. Because of possible risks of suing or repaying the loan, it is usually advised to set up a corporation or LLC when starting your own undertaking.  If you’re sure that your enterprise will be low-profit and low-risk, then the sole proprietorship is perfect for you. So, let’s find out what is an LLC then.

The main difference between these two forms is that corporations will protect your assets if any debts or losses occur. That being said, LLC’s advantages are the possibility of legally separating your personal assets from the enterprise, which is known as personal liability protection. With this protection, your car, house, or bank account are protected if the enterprise suffers a loss.

Let’s take a look at four main factors that make the difference between these two undertakings:

  • Liability protection
  • Branding
  • Pass-through taxation
  • Cost to register and maintain

Suppose your enterprise gets bigger over time, meaning it has a more extensive customer base, and the risk of loss or liability is increased. In that case, you should seriously consider setting up an LLC.

If You Run a Small Business, Why and When Should You Consider the Step of Forming an LLC?

The answer is simple – when you are ready to earn a more considerable profit and expand your business. Since individual entrepreneurship is only suitable for low-profit and low-risk businesses, forming a joint-stock company will allow you to grow your company and take on risk. In addition to personal liability protection, LLC will provide you with tax benefits, credibility from both banks and consumers, and help you grow in profit and risk.

What Are the Disadvantages of LLC?

Besides some additional administrative requirements compared to an individual undertaking, there are several more reasons why a corporation can make your head spinning:

  • Costs are higher, albeit slightly.
  • Taxes can require paying unemployment co.mpensation for the proprietor (which is not the case with an individual enterprise)
  • Banking is a bit complicated factor when it comes to checks – they can’t be cashed to an LLC but deposited into a corporate account.
  • Separate records are required if you’re an LLC owner, meaning your personal history must be separated from your company’s.

What Is an Example of a Sole Proprietorship?

If you’re wondering How do I know if I am a sole proprietor, we’ll try to shed some light on the topic. Many people decide to take advantage of their hobbies to turn something they love into serious work and lucrative at the same time. If you’re one of them, let’s see what kind of enterprises are usually treated as individual proprietorships:

  • Freelance writer
  • Landscaper
  • Fitness instructor
  • Caterer
  • Daycare operator
  • Housekeeper
  • Virtual assistant
  • Financial planner
  • computer/IT specialist
  • Nanny
  • Consultant

So, how to know if this is the right way to structure your enterprise?

If you’re just starting a business and you’re the only proprietor, this might initially be your best bet. By realizing it’s the most suitable structure for you, the lack of paperwork could make you even happier. Besides some licenses and permits, you can apply for an employer identification number (EIN) and avoid using your personal Social Security Number. Also, if you plan to hire an employee or several people, an EIN would be obliged anyway.

Individual Company Taxes

If you’re a sole trader, your business-related taxations and personal taxations are treated as one. It’s because this structure is a pass-through entity meaning that any profits and losses “pass” through you. According to the IRS, you’re your enterprise, and your enterprise is you.

So, what are the most crucial taxes you should be familiar with? Here’s a list:

  • Federal income taxation
  • Self-employment tax, which is calculated as 15.3% of your net earnings from self-employment
  • Federal estimated taxings
  • State income and estimated taxations
  • Sales taxation

Each type has its own requirements for reporting and payment, and if you want to learn more about them, the IRS website will provide you with all details and specifics.

Employees-Related Issues

If you want to hire help for your enterprise, expect a bit more complicated taxes. You should fill a form W-2 for each employee, and your employees will pay some taxes, while you will cover other charges. Here are the main taxes in case you opt for employees:

  • Social security levy
  • Medicare tax
  • Additional Medicare tax
  • Federal unemployment levy
  • State unemployment taxes
  • Local taxings
  • Income taxations

If you decide to hire an independent contractor, the process is more straightforward because you’re not required to withhold or pay taxes on their behalf. But, depending on the annual sum you decide to put aside for these services (if it’s higher than $600), filing a 1099-MISC is a must.

Is It Possible to Save on Your Taxes

If you choose the “S corp” as the taxation option for your enterprise, you may enjoy some tax benefits. For example, it can allow you to pay yourself as an employee or reduce your tax burden.

Advantages and Disadvantages of Being an Individual Entrepreneur

Compared to LLC and corporations, individual undertaking offers advantages and benefits to small businesses if you want to start low-risk entrepreneurship and see how successful it will be. The most important advantages are:

  • No money in advance is required
  • Lack of dealing with legal issues – paperwork, documentation, filing, etc.
  • You don’t need to spend your energy and effort to start it

When it comes to disadvantages, they are serious, and you should consider them carefully before making any decision:

  • No personal liability protection
  • No tax benefits, meaning you pay taxations on your profits and pay full Medicaid and Social Security taxes
  • Limited growth potential
  • Less credibility and branding opportunities

Since one of the biggest risks when starting this form of enterprise is the lack of an owner’s liability protection, think about adequate insurance. With health coverage, auto insurance, liability coverage, and disability coverage, your assets will be protected from potential lawsuits and professional setbacks.

Benefits of Accepting Credit Cards for Individual Entrepreneurs

Whatever your motives for starting a business are, and no matter what goals you have, you must be in line with technical and financial trends. Cashless payment is one of the favorite ways among customers today, which means only one – credit card processing is a must if you want to sell your services or products. Now, you’re probably wondering how to accept plastic payments as an individual entrepreneur? The first step is to apply for a merchant account with a credit process company. After that, you should consider several ways to accept plastic:

  • Through an online website
  • In-person
  • Over the phone

What are the benefits of finding the best credit cards for small businesses?

First, you should inform yourself about business credit card transaction fees and find those that pay fixed-rate rewards. They usually free you of annual expenses, provide big sign-up bonuses, and cheap introductory financing. In short, cashless payment can help get your sole proprietorship off the ground.

GET A QUOTE

It never hurts to know how much you can save.

Get a Quote

Step 1 of 2

50%