Please note that this article has been prepared and is intended for informational purposes only. It is in no respect intended to provide, and should not be relied on for, any tax, legal or accounting advice of any kind. Sole proprietors should always consult with their tax, legal and accounting advisors.
Being a business owner is a huge responsibility and while there is some risk, it can be a highly rewarding endeavor. There is a multitude of reasons why someone may want to pursue a sole proprietorship and several important details to know for those who are interested, so here’s some important information for entrepreneurs to consider before starting a sole proprietorship business.
What Is a Sole Proprietorship Business?
A sole proprietorship (also referred to as a sole trader business) is an unincorporated business that has a single owner. A sole proprietor must report all business income and losses on their personal income tax return. The business is run by one individual and the business is not a separate legal entity. A sole proprietor assumes all the benefits and risks of running their business.
Many people, such as individual contractors and consultants, choose to be sole proprietors because they can do business under their own name rather than creating a separate business or trade name. However, if a sole proprietor chooses to use a different name for their business, most states require them to register the name by filing a document. This document may be referred to, depending on the state, as a certificate of assumed name, application for a fictitious name, or trade name certificate. In general, these can be referred to as "doing business as" (DBA) filings.
Someone would not be considered a sole proprietor if they are registered with the state as a corporation, limited liability company (LLC) or another type of a legal entity. This is important when it comes time for filing taxes, which we’ll discuss next.
What Filings Are Required for Sole Proprietorships?
Generally, there is no upfront paperwork with respect to federal or state tax filings, it simply begins when the sole proprietor starts conducting business.
Also note that just because someone is the sole proprietor of a business doesn’t mean that they can’t hire others but they would need to obtain an Employer Identification Number (EIN) and any other forms required by law. A sole proprietor may also need to obtain necessary licenses and permits before they can launch their business. As mentioned above, if a sole proprietor wants to use a name for the business other than their own, most states require a DBA filing.
What About Taxes for Sole Proprietor Businesses?
During tax season there will be paperwork to report business income and expenses using the Schedule C. A sole proprietor may have to pay both federal and state income taxes based on business earnings as well as self-employment taxes.
What does it mean to pay taxes as a self-employed person? When a person is an employee, their employer typically pays a portion of their Social Security and Medicare taxes and withholds the rest from their pay. When a person is self-employed and a sole proprietor, they must pay the full amount for Social Security and Medicare taxes. A sole proprietor has an option to pay these taxes quarterly so that, come tax season, the sole proprietor isn’t left with a huge tax bill that burdens their finances.
Pros and Cons of Sole Proprietorships
A sole proprietorship is a great solution for so many people, it’s no wonder that many U.S. businesses are sole proprietorship businesses. That said, there are both pros and cons to consider when trying to establish a business and deciding whether or not a sole proprietorship is the best avenue.
Pros of Sole Proprietorships
Here are some of the benefits of a sole proprietorship.
- Easy to start. A person does not, generally, need to take any legal steps to form a sole proprietorship. There’s no need to register with a governmental authority, and there aren’t any major hoops to jump through. Aside from a potential license or permit that may be needed, depending on the state and type of business, there’s very little paperwork, which is going to help get a business moving faster.
- Tax deductions. Another major benefit of a sole proprietorship is the tax benefits, specifically the tax deductions. Any income that is generated from a pass-through business is only subject to a single layer of income tax, and some businesses even qualify for a 20% tax deduction of qualified business income. A lot of money can be saved as a sole proprietor by taking advantage of these tax deductions, especially under the Tax Cuts and Jobs Act (TCJA) from 2017 that runs through 2026.
- Few government regulations. There is lots of flexibility since there are few regulations for sole proprietors. It’s important to keep proper records, file, and pay taxes timely based on the business income.
- Full management control. A sole proprietor oversees and manages all aspects of the business, so there is total control over the operations of the business and how money is received. A sole proprietor can run all of the business finances through a personal checking account.
- Can easily be shifted into LLC. Another big bonus to being a sole proprietor is that if the business grows, it can easily be transitioned into an LLC. A sole proprietorship is a natural jumping-off point to creating a larger and more lucrative business if that’s the right direction.
Cons of Sole Proprietorships
Despite some exciting advantages, a sole proprietorship is not without its limitations. Here are some of the potential drawbacks to consider, too.
- Liabilities. With all of the freedom and control that comes with being a sole proprietor and getting all of the profit, the sole proprietor is also responsible for any of the business’s debts and actions. This means all debts and other obligations are on the proprietor and no one else. If a business takes an unfortunate turn and the sole proprietor is unable to pay the debts, creditors could go after personal assets since there isn’t that separation between personal and business financials.
- Limited resources/capital. Also, keep in mind that it is a sole proprietor’s resources and credit qualifications that are taken into consideration when creating a lending relationship with financial institutions like banks. As such, shares or interest in the business can’t be sold to raise money, so there are some limitations.
- Limited value in terms of selling the business. Because a sole proprietor business is typically so niche in finances and design, it isn’t always possible to sell the business. Business assets as a sole proprietorship are personal assets since the business is not a separate legal entity.
Should Sole Proprietorship Businesses Consider Obtaining Insurance?
A sole proprietor may want to consider purchasing insurance coverage to limit their personal liability. Liability is often considered one of the biggest risks for a sole proprietorship because the business fully relies on the proprietor and their finances, for better or for worse. As a responsible business owner, some contingency planning for business debt or obligations, such as loans, leases, credit accounts, or even legal action are important to consider.
Acrisure can help sole proprietorship businesses find the right type of commercial insurance coverage for sole proprietor’s business industry, financials, and many other personal liabilities or risks. There are several types of business insurance, including:
- Commercial General Liability Insurance. This type of insurance typically covers claims made by third parties alleging bodily injury, property damage and advertising injury caused by the business or its employees.
- Commercial Auto Insurance. This type of insurance helps protect businesses from losses resulting from third-party claims related to bodily injury, property damage, or other losses caused to people or their property by the business’s vehicles. Hired and non-owned auto insurance might be the right choice if the business uses a rented, leased or borrowed vehicle or if a personal vehicle is being used for business purposes.
- Professional Liability Insurance. This type of insurance can help provide financial protection for companies and professionals if a client alleges their work is inadequate or they committed a negligent act.
Business ambitions shouldn’t be put on hold out of fear. It takes some risk and a lot of guts to pursue a sole proprietorship, and with the right support, it can be done confidently. With that said, don’t leave finances at risk and consider finding the right insurance that the business can afford and that offers the right coverage for your business.
Ready to be find the right insurance provider? Acrisure’s robust, AI-powered technology will take the important factors and financial concerns you may have and help you find an insurance provider that is right for your business. Contact us today to learn more about your options and how you can help protect your sole proprietorship from costly risks.