Is Sole Proprietorship the Right Entity Type for My Business?
Taking the leap to start a business is very exciting. The processes and governmental/administrative tasks necessary to start and run a business in the United States can be less exciting and more confusing. GovDocFiling is here to remove the angst and aggravation of filing government documents. We have guided hundreds of businesses — big and small — through the steps to start, build and grow their business.
The first official administrative step to starting a business is selecting one among the various business structures and finding the best fit. There are five main types: Sole Proprietorship, Partnership, Limited Liability Company (LLC), S-Corporation and C-Corporation.
The type of business entity you register is important because it determines the following for you and your company:
- How profits are taxed by the IRS
- How you will be treated in a lawsuit
- The type of bank account you can open
- Additional tax forms required
Take our entity type survey to see which entity type best fits your business needs and if Sole Proprietorship is indeed the right choice for you.
Once you have determined your entity type, you’ll need to obtain an EIN. EIN stands for “Employer Identification Number,” and is also referred to as a TIN, Tax ID Number, Federal Tax ID, Federal EIN or FEIN. All of these names refer to the same thing — a nine-digit number assigned to all entities by the Internal Revenue Service (IRS).
What is a Sole Proprietorship?
If you run a business as an individual without forming an LLC or Corporation, you are a Sole Proprietor.
The biggest difference between a Sole Proprietorship and an LLC or Corporation is liability and taxation protocol. Sole Proprietors are a simple entity where no additional formation is required by the state or IRS, other than an EIN/Tax ID.
IRS’ definition of a Sole Proprietorship: A Sole Proprietor is an individual who owns a company that is not incorporated or registered with its state as an LLC. Properties of a Sole Proprietor:
- The business does not exist separately from the owner or the Sole Proprietor
- The risks of the business apply to the individual person’s assets, including those not used for the business
- The Sole Proprietor reports business income on his or her personal tax return
- A Sole Proprietor may or may not have employees
What are the Advantages of a Sole Proprietorship?
Here are some of the advantages of a Sole Proprietorship and reasons why you should start one:
- Administrative Control: As a Sole Proprietor, you will be completely in charge of your business and how it’s run. You’ll be your own boss.
- No Profit Sharing: You don’t need to share the company profits with anyone and can keep the entirety of the business profits.
- Low Startup Costs: It is cheap to start a Sole Proprietorship and the startup costs are much lower than that of starting an LLC or a Corporation.
- Flexibility to Change: It’s very easy to convert your Sole Proprietorship into an LLC or a Corporation if your requirements change as your business grows.
- Quick Startup process: Starting a Sole Proprietorship is quick and simple. In fact, you can start your Sole Proprietorship filing process simply by clicking on the button below.
Taxation and Liability of a Sole Proprietor
The type of taxation required of a Sole Proprietor is called “pass-through taxation,” meaning that all of the profits and losses from the business will pass through to the individual’s personal tax return. The profits and losses from running your business will go on form Schedule C of the owner’s personal tax return to the IRS.
When reporting profit and loss as a Sole Proprietor, you are required to pay a self-employment tax of 15.3 percent to the federal government.
The individual is personally liable for business and personal assets at risk in a lawsuit.
Example of a Sole Proprietor
You started making jewelry and selling it on Etsy.com. You are making an income from selling the jewelry, and you have costs of making and selling the jewelry. You want to open a bank account for the business that is not your personal bank account. In this case, you will need to file for an EIN/Tax ID for the entity type of Sole Proprietor/Individual.
As another example, if you hire someone to work in your home, such as a nanny or caretaker, and you pay for their services, you are considered a household employer and should also obtain an EIN/Tax ID to account for the payment made to the employee.
Tax ID for Sole Proprietorship and DBA
The legal name associated with an EIN/Tax ID of a Sole Proprietorship will be the name of the individual. How you enter your name on the application for an EIN will be the legal name of the EIN. You can choose to include your middle name or not.
Individuals are allowed only one Sole Proprietor EIN/Tax ID in their lifetime. If you applied for and received a Tax ID from the IRS at some point, but no longer need that EIN or would like to get a different Sole Proprietor EIN for a different purpose, you will need to cancel the original EIN with the IRS. To do this, you must mail a handwritten letter to the IRS with your existing EIN, Social Security Number (SSN) and signature.
You can still have a Sole Proprietorship entity type even if you choose to name the business something other than your personal name. This is called a “Doing Business As” (DBA) or “Fictitious Business Name.” You will need to file the appropriate forms to form a DBA with the county in which you are running your business.
Quickly obtain an EIN/Tax ID for Your Sole Proprietorship
If a Sole Proprietorship sounds like the right option, you will want to get a Tax ID Number so you do not have to use your Social Security Number in business matters.
With your federal Tax ID Number, you will be able to the following things:
- Apply for a bank account in the name of the company
- Acquire credit in the name of the company
- Separate personal identities from most business dealings
- Hire and pay employees
- Engage in business with other types of organizations, including Trusts, IRAs, Estates, Non-profits, farmers’ cooperatives and plan administrators
Frequently Asked Questions
If you want to quickly start a small business, with complete authority on how it’s run, Sole Proprietorship is the right choice for you.
It is a great option for small, local businesses that don’t plan to expand to multiple locations. That’s why a Sole Proprietorship is the preferred option for family-run businesses.
Here are the five key characteristics of Sole Proprietorships:
- The business is not a separate legal entity and is tied to its owner
- Sole Proprietors are personally liable for their business’s financial liabilities and business debts
- Profits and losses go directly to the owner’s personal income
- A Sole Proprietorship allows pass-through taxation — Sole Proprietorship income is taxed as part of the owner’s personal income tax returns
- The business owner has complete authority over how the business is run
The key advantages of a Sole Proprietorship are administrative control over the business and the fact that the owner gets all the business profits.
As a Sole Proprietor, you decide how your own business is run, how long you want to work, etc. You are your own boss and make all business decisions without interference.
Also, you don’t need to pay corporate taxes as an unincorporated business and even your personal income taxes are not as hefty.
As a Sole Proprietor, you don’t just get all the profits, but also need to bear all the losses. The biggest disadvantage of Sole Proprietorship is unlimited liability. This means that you are responsible for your business’s debts and your personal assets can be seized to recover those.
Another disadvantage is that you not only pay income tax, but also a self-employment tax.
Starting a Sole Proprietorship is quicker, easier, and cheaper than forming any other type of business. And with GovDocFiling’s expedited processing, you can start the process by simply filling out one application form. We’ll take care of all the paperwork and legal hassles, while you focus on how to run and grow your business.