What Is an Sole Proprietorship? Definition & Simple Structure Breakdown
Sole proprietorship Details & Explanations
Most small businesses in the US are set up as “sole proprietorship” as it is the easiest and cheapest way to start a business. According to IRS data, there are more than 30 million small businesses in the United States. More than 25 million of these are businesses that comply with the “Form 1040 C” Schedule. Therefore, they pay taxes as sole proprietors. A sole proprietorship is the easiest and fastest way to create a business In The US.
What is a Sole Proprietor?
If you carry on a trade or business as a self-employed, it’s a sole proprietor. A sole proprietorship, also known as “a sole tradership.” It’s individual entrepreneurship. It’s a type of enterprise owned and run by only one person without any extra employees. A sole proprietorship is a kind of business structure linking the owner of a business with his company.
A sole proprietorship, referred to as a sole trader or an entrepreneur, is an unincorporated business with only one owner. Sole Proprietor pays personal income tax on profits earned according to the business.
A sole proprietorship is a one-person business of any kind; if the business owner doesn’t register his business with the state but does have income and expenses separate from his regular household expenses, it’s clear that he is the Sole Proprietorship.
Definition of Sole Proprietor
A sole proprietor is self-employed. These types of companies don’t have an employer, so there is only a business owner. Sole Proprietors categorize individuals who set up and run their own businesses.
Sole Proprietorship is the oldest and simplest form of business ownership. A business owned by more than one person cannot be a sole proprietorship. In a sole proprietorship, the business is not a separate entity from the owner of the business.
According to the IRS, a sole proprietor is a self-incorporated business. It’s totally a business; someone who has it. A sole proprietor filed in accordance with the IRS-designated class is different from a corporation or sole proprietorship LLC.
Benefits of Sole Proprietor
The most important benefit of a sole proprietor is that it is a form of business that can be created simply and without formality, supporting the American entrepreneurial spirit. Especially young entrepreneurs may hesitate to take a step in the business creation process by establishing a company or LLC. They may not want to make the necessary expenses to establish a company and deal with official documents without seeing whether they can succeed in a business.
A sole proprietor is well suited for freelancers, startups, artists, musicians, e-shop owners, those who work from home, or those who work from personal or physical strength. Hundreds of different business lines such as gardening, dog sitting, personal trader, and so on are available without forming a corporation or LLC. People who do this type of work only do business with their own skills and efforts. On the other hand, the common point of all those who do these jobs is that they do not have the capital or that their work requires knowledge, skills, and physical strength, not capital.
Today, the prevalence of working from home makes freelance jobs more popular. Thanks to the Internet, it is possible to find people who make a product or provide a service and reach them without an intermediary. Thanks to sites such as Amazon, ETSY, and Fiverr, many professions such as small-scale businesses, artists, craftsmen, writers, software developers have the opportunity to market their products and services to the entire USA and the world. Its clear that sole proprietors will be growing, and this is how business trends will evolve.
How To Form A Sole Proprietor
State registration is not required for a sole proprietorship to operate. While all other business types such as Corporations, LLCs must complete a registration form in the state in which they do business, it is effortless to start trading for a sole proprietor.
Things to Do to Establish a Sole Proprietorship:
a) Create a business name
b) Set an address for your business (this can also be a home address)
c) Apply for a business license in your city or county, if required, based on the type of business you do
d) If you want to run your business from home, get permission from your location. (Local administrations require people working from home to inform the local administration about this issue and register household businesses to control factors such as traffic, pollution, and noise.)
e) Establish a business checking account so that business expenses related to your business do not mix with your personal expenses.
f) If the Sole Proprietorship is required to register with federal or state agencies, do so.
g) If you are going to sell a taxable product or service, register with the tax office in your state.
h) Sole Proprietors do not require a separate bank account, so this is not a legal requirement. However, it would be appropriate to open a separate bank account so that personal money transfers and company payments are not mixed.
For Sole Proprietors, the EIN is not a legal requirement. These types of businesses consist of a single business owner, i.e., there is no need for an EIN as there is not more than one employee, and there is no need to file an excise tax or retirement plan tax return. A sole proprietor can use their taxpayer identification number (SSN) as their social security number instead of the EIN.
The EIN is not required for sole proprietors, but there are some advantages to using an EIN. For example, using an EIN provides personal protection against identity theft. By using an EIN, you conveniently separate your personal finances from your business finances. Sole proprietors with EINs do not have to give their personal SSNs to customers or suppliers with whom they do business.
Tax ID Numbers at a Glance
A tax number is not required for sole proprietorships. Sole proprietorship holders can use their own social security number as a tax number. However, an EIN is required for sole proprietors filing a pension or excise tax return.
Sole Proprietorship Tax Liability
Sole proprietors pay taxes on business income on their personal tax returns. As a sole proprietor, you must report all business income or losses on your personal income tax return; The business itself is not taxed separately. The IRS calls the taxation applied to sole proprietors “provisional taxation” because the tax liability lies with the business owner, not the business.
The sole proprietorship owner pays taxes on both his income from business activities and the sum of his personal income. The sole Proprietor pays the tax on their income listed on their 1040 tax return annually. In addition, Sole proprietors must pay quarterly taxes on income from their activities. The most important disadvantage of sole proprietorships is that they do not have tax exemptions. Sole proprietorships are not considered a separate legal entity by the IRS, so sole proprietorships cannot apply to the IRS for tax exemption on any matter.
Characteristics of Sole Proprietorship
a) No Legal Formalities
There are no laws, company formalities, and regulations that must be followed for sole proprietorships. These businesses can only start their operations with a business license, without the need for registration, registration, etc. Similar to initial transactions, closing transactions are also easy. Since it is a personal initiative, that is, it is not in the status of a company, it is not necessary to take any legal action for the dissolution of the business.
b) Liability
Since there is no distinction between the business and the entrepreneur in this type of business, the business owner is responsible for all debts and obligations of the business. If the company is subject to a legal payment sanction or bankruptcy, the business owner’s personal assets will be collected. For example, a debt that is legally overdue may be collected through money in the business owner’s bank accounts or through the sale of property such as a house.
c) Risk and Profit
Sole Proprietorship all risk and profit lie with the owner. All profits arising from the income of such businesses will be written to the account of the owner of the business. The sole winner is the business owner, as no shareholders are arising from a partnership or corporation status. However, the risks are his own. In case of loss, legal problems, or bankruptcy of the business, the person who will suffer from this will be the business owner.
d) No separate legal identity
There is no distinction between business and business owners. That is, all legal actions that the business will face, all legal responsibility belongs to the business owner. For example, if there is a loss or legal sanction as a result of the activities of the business, the sole addressee of this is the owner of the business. The business owner is affected by all legal processes of the business.
e) Continuity
The life of the business depends entirely on the business owner. Not only bankruptcy or closure but also the will of the operator to work or health reasons affect the future of the enterprise. For example, a corporation or LLC has a corporate entity independent of shareholders. Even if the shareholders change, the existence of the company is not affected. However, when a Sole Proprietorship operator dies, the business ends. If the operator decides to retire, the business is closed.
f) Control
Sole Proprietorships are generally the easiest to control, as they are simple and small businesses and can be managed by a single person’s decisions. The sole owner of the business controls all the processes of the business. However, as the business grows, the number of products and customers increases, or the technical and financial processes related to the business’s content becomes more complex, this advantage turns into a disadvantage because the control of a single person will be insufficient.
Advantages of Sole Proprietorship
A Sole Proprietorship type business has many advantages in terms of ease of legal processes, especially establishment and closing procedures. However, there are disadvantages to starting this type of business.
a) Quick Decision Making
The Sole Proprietorship consists of a single person, so it does not need to consult partners or shareholders when making decisions. Rapid and sudden developments and instant opportunities in the markets can enable such businesses to take action faster than large companies.
b) Confidentiality
The sole owner of the business is the owner of the business. Therefore, it is easy for information about the business not to leak out and protect confidential information about the business and its products. In short, the information security of the enterprise is completely under the control of the business owner.
c) Direct Incentive
All profits and losses related to the business belong to the owner of the business. Therefore, the owner of the business also benefits from other possible results of business activities. If the business is deemed worthy of an incentive due to its sector or the region in which it is located, this will be reflected by the business owner.
d) Achievement
The only stakeholder in the success of a business is the owner. If the business is successful, the only reason and therefore the person to be appreciated is the business owner. Trading is basically done to make money, to get returns, but success is also a severe motivation. The fundamental drive of many business ventures is the drive to succeed.
e) Easy opening and closing of the business
The opening and closing procedures of sole proprietorships are easy. There are no legal processes and formalities. For entrepreneurs, the transactions must be easy and inexpensive when starting a commercial activity. It is a fact that entrepreneurs while choosing a business type, search for closing procedures and formalities as well as opening. Business types with long closing processes and complex legal processes are less preferred.
Sole Proprietor Restrictions:
Sole proprietorships are the type of business that is least subject to state rules and regulations of all company types. However, the sole Proprietorship must still comply with the state’s licensing requirements in which it is located and observe local regulations.
There is no legal distinction between the individual and the business In a sole proprietorship business type. The owner of the business is also responsible for everything and, therefore, the penalties and sanctions arising from the legal processes. The business owner and the business itself are a whole. Businesses may use a different business title than the business’s legal name.
a) Rules and Regulations for a Sole Proprietorship
Sole proprietorships are the most common type of business in the United States due to the simplicity of incorporation and dissolution, low costs, and easy legal processes. Legal regulations related to sole proprietorships generally determine the legal limits related to the standard operation of the enterprise and the activities of the enterprise. As with companies, there are no detailed legal regulations and rules regarding the operation and processes of Sole Proprietorships.
b) Becoming a Business Entity
The legal identity of the business owner represents the business, so it is not necessary to form a company structure, such as corporations or LLCs.
Sole Proprietorship don’t need to register at state’s secretary of state,
Sole Proprietorship doesn’t need to create bylaws or articles of incorporation.
Sole Proprietorship has to get all of the business licenses required for any business in the state and city where it’s based.
Sole Proprietorship also has to get licenses or permits specific to their industry. (like medical licenses and food service permits)
c) Sole Proprietorship Business Autonomy
A Sole Proprietorship may operate with complete freedom within the bounds of the law. Since a single owner manages the Sole Proprietorship, it is free to determine all decisions and ways of working on behalf of the business. The business owner does not have to consult or seek approval from partners or shareholders, as in LLCs and corporations. A Sole Proprietorship is autonomous, has no partnership ties with other businesses, can trade more freely than any other type of company as long as it does not depart from their legal process, as government restrictions on Sole Proprietorship are limited.
Taxable Earnings
The profit and loss of Sole Proprietorships determine the tax they will pay. Because they do not have a separate entity like a business, tax status and payment processes are the business owner’s responsibility. The business owner is responsible for tax liabilities. Business debts create a liability bond, including the personal assets of the business owner.
For federal income taxes, sole proprietors are required to complete “Form 1040 Schedule C“. Basically, “Schedule C” summarizes business income by listing gross revenue and all of the types of business expenses Sole proprietorships incur. Deductions cover different items, for example, rental costs, maintenance and repair costs, advertising and marketing expenses, etc.
If your sole Proprietorship earns a net profit, you must enter this sum on your Form 1040 as business income. If your business incurs a net operating loss, you can use this amount to offset earnings from other sources, such as additional jobs you held throughout the year.
Sole proprietorships must enter their net profits on Form 1040 as operating income. If the business is making a loss, the loss can be used to offset the business owner’s earnings from other sources such as additional work or rent during the year.
Sole Proprietorship Pros & Cons
- Easy and inexpensive to form:
- Complete control.
- Simplified tax preparation.
- Unlimited personal liability.
- Hard to raise money.
- heavy burden
Examples Of Sole Proprietor
Most of the small businesses operating in your town or city have Sole Proprietor status. The barber where you cut your hair, the paint shop where you paint your house, the marketer who comes to your door to sell cleaning products, your neighborhood greengrocer, your dentist, and hundreds of other professions operate in the status of Sole Proprietor.
Sometimes a business is built by entrepreneurs with investment experience, with certain capital, and a forward-looking business plan. This type of business can be formed as an LLC or corporation at the establishment stage. But most businesses start out as a small venture, a personal effort, a startup. At the initial stage, the capital of the entrepreneurs is limited; there are no definite predictions for the future of the business. This is why most companies in the US are initially set up as Sole Proprietors.
Due to the nature of some work, it can always continue in the same way. For example, a barber, a gardener, a butcher, a doctor establish a business where they will work alone, and they can continue in this way for the rest of their lives. However, the butcher can enlarge his store and take employees with him. A doctor’s office can turn into a hospital over time. That is, every business has growth potential, but some businesses routinely stay the same. The number of employees and the size of the business do not change.
Most small and medium businesses start out as sole proprietorships, but business can grow over time, and the company’s structure may change accordingly.