As far as taxes are concerned, there is no distinction between the business and the individual owner in a sole proprietorship. The owner is entitled to all business profits and is also personally responsible for all debts, losses, and other liabilities. Unlike a limited liability company (LLC) or an S-Corporation, sole proprietors are considered unincorporated. A sole proprietor can exist in a variety of industries. A few common examples include:
A freelance graphic designer is considered a sole proprietor of their business.If a teacher runs a tutoring business on the side, the tutoring would be considered a sole proprietorship.A small landscaping businessIndependent sales consultant Personal trainerPhotographer
How Sole Proprietorship Works
There is no formal process required to become a sole proprietor. A person who owns their own business automatically receives the title by default, and there is no cost associated with the designation. If you are running an independent business, you may already have a sole proprietorship without knowing it. In a sole proprietorship, the owner’s taxes and the business’ taxes are considered one and the same—they do not need to be filed separately. This makes sole proprietorship taxes relatively simple compared to taxes for other incorporated structures. Sole proprietors can hire employees, whether they’re full-time or independent contractors. During tax time, a sole proprietor must fill out Form 1040 for their income, estimated, and self-employment taxes. If they hire employees, they must pay standard labor taxes, including federal unemployment and Medicare. A sole proprietor maintains total control over all business decisions without having to consult shareholders. This means they have complete access to the business’ profits, but they also incur all of the liability associated with running the business. If an employee is injured on the job while working for a sole-proprietor landscaping company, for example, the employee could theoretically sue the owner for all of their personal assets, according to April Walker, lead manager for Tax Practice & Ethics at the American Institute of CPAs. Or, if a sole proprietor defaults on their loans, a bank could seize the owner’s property. Under incorporated structures such as LLCs, on the other hand, claimants may only access the business’ assets.
Alternatives to a Sole Proprietorship
For those hoping to grow their business beyond a sole proprietorship, the most common alternatives are:
Single-Member Limited Liability Corporations: This status allows business owners to file their business and individual taxes jointly while incurring little personal liability. Annual fees apply and they vary by state. Limited Liability Companies (LLCs): For businesses looking to grow and include more owners, LLCs are a common option. Owners must pay fees for this incorporated status, and they require separate taxes for businesses and owners. S-Corporations: For small businesses with multiple owners, this incorporated status may allow for a tax break on Social Security and Medicare tax, making it an attractive option for proprietors with employees, according to Walker.
How Much Does a Sole Proprietorship Cost?
There is no fee specifically associated with the sole proprietorship designation. However, sole proprietors must pay for their requisite licensing and permit fees, as all businesses need to. Remember that licensing and permit fees vary by industry and state. Use the SBA’s Licensing & Permits tool to identify federal, state, and local permits, as well as licenses and registrations you may need to run a business.
