If you are an aspiring company owner researching which business entity is the right choice, this article can come in handy. We’ll break down what sole proprietorships are, how they work, and how they compare to other entities.
- A sole proprietorship is the only business entity with no legal requirement to form it, which means it doesn’t need paperwork or legal filings.
- This type of business entity is often referred to as an “unincorporated business.”
- A sole proprietor can hire employees, but it must fulfill all hiring legal papers according to the laws of the State where business operations are conducted.
- If you operate an unincorporated business and are the only owner, you are automatically a sole proprietor.
- Sole Proprietorships are the most common type of business entity in the U.S.
- A sole proprietor is personally liable for all claims against his business, so as the business grows, the better option is to form an LLC which provides more protection to the owner.
What Is a Sole Proprietorship?
A sole proprietorship is an unincorporated business with one person or a married couple as the owner. A sole proprietorship doesn’t demand high legal requirements necessary to form it, so it is possible to create it for little cost and maintain it without further paperwork or legal filings.
Unlike corporations and limited liability companies (LLC), which are state-registered business entities, a sole proprietorship doesn’t require you to file formation papers with the State.
So if you’re running a business on your own and haven’t registered the company, you already have a sole proprietorship. This being said, you might still have to obtain business licenses and permits to comply with local laws.
Can a Sole Proprietor Have Employees
Yes, sole proprietors can have employees; they just need to put it all under a legal framework, that is, fill out tax and other hiring legal papers so that the businesses fulfill the laws of the State where operations are conducted.
When a sole proprietorship starts hiring people, its owner must get the employee’s identification number (EIN), make a copy of their Social Security card, and fulfill appropriate tax forms on time!
Why Sole Proprietorship Is So Popular Among Entrepreneurs
Sole proprietorships are so common because the setup is effortless. If you’re operating an unincorporated business and are the only owner, you are automatically a sole proprietor; it is simple like that!
Currently, 86.4% of non-employer businesses are sole proprietorships, making this the most common type of business entity in the U.S!
A sole proprietorship is popular because:
- It is easy to form it; there are no official registration requirements.
- It has only one owner (or a married couple) who is entitled to all profits.
- A sole proprietorship is run by a single owner who is not subject to documentation or compliance regulations (unlike corporations)
- It is taxed as a pass-through entity—meaning the business income and profits are passed on to the owner’s tax return and subject to their individual income tax rate.
When it comes down to it, however, there are both advantages and disadvantages of launching a sole proprietorship—and this entity type will not be well-suited for every small business owner.
Sole Proprietorship Examples
Given how common they are, sole proprietorship examples are everywhere you look.
Some examples of sole proprietors are:
- Virtual assistants
- Home-based business owners
- Fitness Instructor
The list goes on and on! Essentially, any time you open a business without business partners, you have a sole proprietorship. The business starts the moment you begin offering goods or services for sale.
You can elect to incorporate your business or register as an LLC, but in the absence of filing papers with the State, you have a sole proprietorship on your hands.
How Do Sole Proprietorships Compare to Other Entities?
We will briefly discuss the differences between business entities to show aspiring business owners what direction they should go.
By knowing the differences between business entities, you can determine if it is sole proprietorships good fit for you and your business!
Sole Proprietorship vs. Independent Contractor
First, you might wonder what the difference is between a sole proprietorship vs. an independent contractor.
This distinction may be confusing initially because an independent contractor (unlike an LLC or corporation) is not an entity type—but instead is a designation used for someone who works for someone else and receives a 1099-MISC form at the end of the year.
In this way, someone can simultaneously be a sole proprietor and an independent contractor.
As an example, say you have a freelance writing business and are contracted to complete work for Company X. Your freelance writing business is a sole proprietorship, as you’re the only owner—and you’re an independent contractor working for Company X (as opposed to being an employee of Company X).
To this point, however, not every sole proprietorship is an independent contractor—a small retail store that sells shoes, for instance, wouldn’t be an independent contractor.
Sole Proprietorship vs. LLC
Unlike an independent contractor, an LLC is another popular entity structure among small business owners.
There are several differences between LLCs vs. sole proprietorships:
- Formation: To form an LLC, you must file formation papers, called articles of organization, with the State. On the other hand, a sole proprietorship is the default form of ownership for a single-owner company.
- Taxes: LLC owners can choose whether to be taxed as a disregarded entity or as a corporation. A sole proprietor must report business income and losses on a Schedule C attached to their personal tax return.
- Liability: Members of an LLC are shielded from personal liability for business debts and obligations. Sole proprietors face personal liability for any lawsuits or debts of the business.
Other than these core differences, it’s costlier and more time-consuming to maintain an LLC than a sole proprietorship!
For instance, most states require LLCs to file annual reports and pay annual taxes. However, many business owners opt for an LLC to receive limited liability protection.
Sole Proprietorship vs. Corporation
There are also several differences between sole proprietorships and corporations:
- Formation: To form a corporation, you must file articles of incorporation with the State. As discussed, sole proprietorships don’t require a business filing for initial setup.
- Taxes: C-corporations and S-corporations have different tax rules. C-corps are subject to a flat 21% corporate income tax. In an S-corp, similar to a sole proprietorship, business income and losses pass through to shareholders’ tax returns.
- Liability: Shareholders in a corporation are shielded from personal liability for business debts and obligations. Sole proprietors, as mentioned above, can be sued personally by business creditors.
Ultimately, a corporation is the most complex business entity, with three layers of ownership and management: shareholders, officers, and directors.
Whether you’re a C-corporation or S-corporation, there are several corporate formalities that you need to follow, such as holding shareholder meetings to keep your corporation in good standing.
For the reasons mentioned above, many small businesses opt for an LLC, partnership, or sole proprietorship.
How to Decide Is Sole Proprietorship Right Choice For Business
At the end of the day, if you’re unsure which business structure is proper for you, you must consult an accountant or business attorney for advice. These professionals can help you weigh the options and make the most informed decision.
Ultimately, when choosing a business structure, sole proprietorship offers the value of simplicity, but there are many potential downsides. Among them are higher taxes, more legal exposure, and more difficulty landing new business.
Therefore, you’ll want to think carefully about which entity type is best for you—you might even consider changing your sole proprietorship to an LLC or corporation as your business grows!