Big Business names usually start with small steps. Even if you dream big, most likely than not, you should start small and get your venture up steam. Hence, being the simplest business form, the benefits of a sole proprietorship are extremely popular among beginner entrepreneurs.
How will you benefit from starting your business as a sole proprietor? What are the pitfalls to be considered? What are the tax implications? We’ll answer these questions below to make the startup process less intimidating and more comprehensible for you.
What Is a Sole Proprietorship?
As the name suggests, a sole proprietorship is an entrepreneurial structure owned by a single person. Though this business form legally links the enterprise with its owner, it’s not a legal entity since it requires no state registration.
In other words, a sole proprietorship is an unincorporated, unregistered, or so-called disregarded entity. As such, it’s directly associated with its owner making him or her responsible for all business commitments.
The main features of this business form are as follows:
- It needs no federal registration to operate;
- It’s automatically named after its owner;
- It entails no complex formalities or confusing paperwork;
- It offers pass-through taxation;
- The owner is considered to be the one with the business;
- The owner is liable for all the business commitments and operations;
- There are no limitations on the number of hired employees and activities to run.
Sole Proprietorship Advantages
A sole proprietorship has a lot going for it, as simple as it is. Though not perfect for all business scenarios, this entity type is a great starting point for beginner entrepreneurs or aspiring startuppers. Let’s review its significant benefits.
An Owner Is the One in Control
In a sole proprietorship, a business owner is tied to the venture, thus being the sole person to own, manage, and control it. It means you are the only decision-maker. You have neither to get other stakeholders’ or legal partners’ agreement nor to report to them.
This will give you all the freedom you want to develop your business your way and make it move in a direction you deem necessary. You’ll enjoy unlimited flexibility in strategic planning and growth planning and get as much leeway for experiments as you need.
A few other hassles you won’t have to worry about include:
- Board meetings:
- Paperwork routines;
- Compliance restrictions;
- Filing and reporting rules.
Being a single owner, you’ll get the level of privacy and independence no other business form offers. You’ll be able to test different business models and concepts and exploit innovations without agreeing with anyone but yourself.
No-Frills Entity Setup
As an unincorporated entity, this enterprise form requires no state registration and entangles no paperwork and legalities of LLC and corporation setup. It’s one of the biggest sole proprietorship pluses.
This type of entity is brought to life as soon as you start transacting business activities and paying taxes via IRS forms. As such, it’s a great choice for startuppers, small private entrepreneurs, and anyone who seeks to create some side hustle in addition to their main job.
Note, though, that this business form is open to licensing requirements similar to registered entities. In the meantime, being exposed to fewer regulations and limitations, it allows for quicker and easier business scaling.
Low Business Costs
Registered entities come with registration costs. Thus, an LLC entails a state filing that might be as high as $300 or even $500 in some states. That’s not to mention annual payments to maintain your entity’s legitimacy. And you can’t skip those charges.
Compulsory fees can eat up a hole in your already tight startup budget. With a sole proprietorship, you’ll save on formation expenses and won’t have to pay annual fees to keep your entity registration active.
Ongoing business costs are also lower for sole proprietorships since there are fewer statutory regulations to follow.
Taxation is a kind of frightening thing about business, especially for beginners. Business taxes can be complicated and quite a burden. At the same time, taxes are strictly monitored and regulated by the government.
In the meantime, a sole proprietorship keeps the fuss and implications of business taxes at bay. It offers a straightforward taxation system, which is much simpler than that of incorporated entities.
The key benefits of sole proprietorship taxation are as follows:
- You are not required to get an EIN and can use your personal Social Security Number for business purposes;
- Business income and losses are to be reported on the owner’s personal tax return, which means there is no income tax to pay at a business level;
- Business income is taxed under the owner’s individual tax rate which often appears lower than corporate income tax rates;
- Sole proprietorships take advantage of deductible business costs some of which are not available to other business forms.
Under the IRS rules, sole proprietors are considered self-employed. As such, they are entitled to the same host of tax write-offs as any self-employed worker to cut down their taxable income.
The cost of business assets intended to serve you for a long time such as equipment, vehicles, or real estate can be gradually reimbursed via tax deductions.
Thus, you can write off depreciation and amortization costs on your tax returns until you recoup the cost of the asset. Normally, it takes a number of years. Once the asset price is compensated, you are not allowed to deduct it from tax payments anymore.
When traveling for business, a sole proprietor is permitted to reduce the taxable income for the amount of travel-related costs such as transportation, hotel, meal, and even entertainment expenses. The latter embraces some gifts you can make to your clients or partners, concert tickets, or restaurant cheques.
If you use your car for business purposes, you can deduct vehicle-associated costs from the taxable income. The amount of deduction will depend on the scope of use.
In other words, you can write off the cost of mileage driven for business as well as maintenance and repairs costs.
Employee and Insurance Related Costs
You can deduct their salaries from your federal tax return if you hire employees to help you out with your entrepreneurial activities. Likewise, professional and liability insurance policy costs can be written off.
However, insurance required by the state and Worker’s Compensation insurance are non-deductible since these are not allowable expenses.
Qualified Business Income Deduction
Under the Tax Cuts and Jobs Act of 2017, small business owners are entitled to cut down their taxable income by 20% if it is below the amount stipulated by law for the current fiscal year. Thus, in 2022, the limits are $170,050 and $340,100 for single and joint filers accordingly.
A sole proprietorship offers easy banking with no-hassle business establishment, simple management, and straightforward taxation. There is no need to open a separate bank account for business.
You can use your personal checking account to maintain business financial transactions. Just make sure you account for business and personal assets separately.
Unlimited Number of Workers
Being their own bosses, sole proprietors also have an opportunity to hire as many employees as they deem necessary. This gives them the freedom to engage valuable staff and create a dream team without going into a formal legal structure.
For example, when developing a resource, entrepreneurs can either turn to Shopify experts or hire a team of developers to work in their company.
This opportunity is a big plus for pilot and innovative projects limited in funds and in need of high-value resources. They get access to the talented workforce without digging into the filing formalities.
Name Protection Option
Though a basic business form, a sole proprietorship gives access to certain legal benefits available for incorporated entities. Namely, this is true for business name protection.
Existing beyond official registration, sole proprietorships are automatically named after their owners. Yet, you can transact business under a different moniker, thus, ensuring a legal protective shield for your entity name.
- You can trademark your business name to make sure it is unique and used by no other company or business entity across the country;
- You can register a DBA (doing business as) name to make your business name distinguishable at a local level.
The US Patent and Trademark Office register trademarks, and DBAs are to be filed with the state or county clerk’s office. While trademarks are to be renewed once a decade, DBA renewal dates are state-specific.
A Foothold to a Bigger Business World
The above benefits make a sole proprietorship an inviting entry into business for many aspiring entrepreneurs who know little to nothing about the business yet strive to dig in.
Many well-known business names (Amazon and eBay are among them) have started small as sole proprietorships and grown big into globally recognized giants.
A sole proprietorship allows for avoiding a big business’s legal risks and difficulties while still enabling you to dip your toes into it. It serves as a stepping stone for beginners since you can convert it to a registered entity anytime.
Sole Proprietorship Disadvantages
With many welcoming benefits of a sole proprietorship, not everything in the garden is rosy. There are certain related risks and drawbacks too. And you should be aware of them.
- Complete Personal Liability
Being your own boss and a single business owner, you are the only one in charge. You are your business and are fully responsible for it. It means that:
- You’ll be personally liable for any business commitments, debts, tax, and financial issues;
- Your personal assets can be used to repay business debts, cover employee injuries, or settle lawsuits against your entity;
- You are not separated from your business and have no access to the legal protections of registered entities.
The legal responsibility is the price a sole proprietor has to pay for the liberty and flexibility in other aspects.
- Limited Access to Financing and Fund Raising
At some point, any business needs additional financing. Typically, enterprises rely on bank loans and credits to source funds for maintaining business growth and scale-up. However, a sole proprietorship is limited here.
Banks are reluctant to give money to unregistered entities, especially when they share bank accounts with their owners. They prefer to work with established legal persons independent of their owners and featuring their own credit histories.
You can take a personal loan to finance your business. Yet, again, you’ll be liable for this with your personal funds and property should your business fail to repay it.
Taxes Under a Sole Proprietorship
Sole proprietorships are classified by the Internal Revenue Service as disregarded or pass-through entities.
- They don’t pay federal income taxes as legal entities;
- Business incomes and losses pass to a personal tax return of an entity owner and are levied at his or her personal tax rate;
- A sole proprietor is to pay a self-employment tax to cover compulsory Medicare and Social Security contributions;
- All sole proprietorship profits are taxed. Whether you leave the money in the bank account for further business use or withdraw it, the whole amount of profit less deductible expenses will be levied.
A sole proprietorship is an appropriate structure for newcomers, first-time entrepreneurs, and small business owners who are on a tight budget or stand at the beginning of their business journey.
Ensuring ease of setup and management, flexibility, and affordability, this type of entity will lead you to the world of modern business and help you gain confidence and experience.
As soon as your enterprise grows and starts generating higher profit, it’s high time to consider switching to an incorporated entity to minimize the tax burden and get more personal protection for yourself.
Benefits Of A Sole Proprietorship FAQ
This business form owes its popularity to its ultimate simplicity, straightforward taxation, no-fuss management, and flexible opportunities you get business control, development, and scaling.
A business owner is the one in charge of the enterprise and the one to get the business profit and manage it.
Being self-employed, sole proprietors pay themselves. Yet, technically, it’s not a salary since the payment is not a deductible expense. It’s rather a “draw” they get via a business cheque.
Yes, sole proprietors can use their personal checking accounts for business purposes without limitations. Yet, it’s highly recommended that you set up a separate account for business to split your personal and entrepreneurial expenses.
This article Top 9 Benefits of a Sole Proprietorship originally appeared on Rick Orford - Invest, Earn More Income & Save Money.