It's the simplest business entity: the sole proprietorship. But its ease of startup can give way to some misconceptions about what it is and how it works. Read on to get the full scoop on sole proprietorship businesses.
What are sole proprietorship businesses?
In a nutshell, a sole proprietorship is a single-person, unincorporated business.
From an operational standpoint, you automatically create a sole proprietorship when you start doing business. It doesn't come with the fees of creating an LLC. or incorporating. And from a tax vantage, there is no separation between you and your business.
This means you can report your earnings or losses on your personal tax return (IRS Form 1040). But the downside is that you personally assume all financial risk for the business.
Why are sole proprietorship businesses the most common type of businesses?
There were 23 million sole proprietorships operating in the U.S. according to 2014 data from the Tax Foundation. The popularity of the entity is attributed to its minimal regulation and ease of startup and tax filing.
Aside from these benefits, the entity grants entrepreneurs a unique sense of pride in ownership. Since you have no partners or employees, you reap all the after-tax profits your business earns. On the flip side, you carry all of your business's liabilities squarely on your shoulders.
Do you need a business license if you're a sole proprietor?
It depends on what type of business you're operating and where. Federal, state and local licensing requirements apply to some, but not all, sole proprietorships.
Business licensing at the federal level is usually only required for regulated businesses like those that produce drugs or distribute alcohol or firearms.
State licensing requirements often apply to sole proprietors in regulated industries like medicine or law. They're also common for businesses that distribute alcohol--for example, a restaurant.
City or municipality business licenses are the most common business license requirements. These can include licenses for a business activity or occupancy.
In addition to licenses, you may need to obtain permits. For example, having a "Doing Business As" name that differs from your real name. You may also be required to obtain permits for building codes or zoning clearances.
Contact your local Small Business Development Center office to identify whether you need business licenses and permits and which you need.
Do need a business bank account for sole proprietorship businesses?
It's not a requirement, but it's recommended. For LLC owners, opening a business bank account maintains the notion of a firewall between one's business and personal assets.
Such a division doesn't apply for a sole proprietorship since you're personally on the hook for your business's liabilities. But it can still be of help when doing business and come tax time.
When you send checks, it looks more professional when that check comes from your business bank account as opposed to your personal account.
When it's time to make business deductions, a business bank account makes it easy to identify transactions that were business-related.
And should you get audited for claiming a business deduction, it's easier to prove your case when your business and personal transactions are tracked separately.
How do I pay tax as a sole proprietor?
Most sole proprietors will have to pay both federal income tax (and state tax if applicable) along with self-employment tax. The self-employment tax rate is 15.3 percent and the amount is based on your net profit from business. You should use Schedule C, Profit or Loss From Business, to determine that net profit.
Most sole proprietors will need to pay self-employment tax on a quarterly basis. These payments are known as quarterly estimated tax payments. Use IRS Form 1040-ES to calculate these payment amounts. Once you figure the amount, you can pay estimated taxes to the IRS using a number of methods.
