A sole proprietorship is a simple and common structure. It’s chosen when you own an unincorporated business by yourself.
Estimated reading time: 4 minutes
What’s a sole proprietorship?
A sole proprietorship is an easy and quick way to establish a business. It’s a structure for unincorporated one-person businesses. It’s also known as a sole trader or sole prop.
Related: The 4 Ps of marketing
One of the key features of a sole proprietorship is that there’s no legal separation between you and your business. You’re personally responsible for everything that happens in your business.
As a sole proprietor, you’ll pay personal income tax on the profits that you earn from the business. You’re also responsible for the debt that the business accrues or any lawsuits.
To get started as a sole proprietor, you must apply for a business license with your state. Typically, it’s with the Department of Revenue for your state.
When you’re getting a business license, you can choose to call the business your name or get a trade name.
A trade name is also known as a DBA, which stands for “doing business as”. It’s a way to call your business something other than your name, which will benefit you because you can build a brand.
All profit and loss for sole proprietorships are reported with your personal federal income tax return.
You must file a Schedule C in addition to the standard Form 1040. To file a Schedule C, you’ll need the following information:
- Business name and type.
- Income information.
- Cost of goods sold (COGS).
- Vehicle information if you used it for business.
- Other expenses that don’t fit the main categories.
Another tax that you must pay is the self-employment tax, which will be on Schedule SE.
Since it’s not being withheld from your business income, you may need to use Form 1040-ES for estimated tax.
Contractors, home-based businesses, artists, photographers, and consultants are examples of people that can be a sole proprietor.
The following are the benefits and advantages of a sole prop:
- Quick and easy to establish.
- Complete control over ownership and decisions.
- Annual state filing isn’t required.
- Ability to deduct expenses.
- Taxes are simpler.
If you’re looking for the least expensive way to start and maintain a business, a sole prop is a great choice.
While there are many benefits, it also comes with downsides. The following are the disadvantages of being a sole proprietor:
- No legal separation.
- Liable for lawsuits and debt that the business incurs.
- Profits are reported on your personal income tax return.
- Difficult to raise capital or sell the business.
- Hard to get bigger deals or contracts.
Liability exposure is a big reason that people will look at other business structures, such as a limited liability company (LLC).
Speak to a lawyer or tax professional to understand the pros and cons that are unique to your situation.
If you’re starting a new business by yourself and want a simple start-up process, the sole proprietorship structure is a great choice.
Keep in mind that it doesn’t offer legal separation, and you’re personally liable for everything. Also, you can restructure at any time.
Featured image courtesy of Canva.
About David Em
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.