What is a sole proprietor? A sole proprietor is not a legal entity. The IRS defines a sole proprietor as someone who owns an unincorporated business. A sole proprietorship is a simple, default entity formation. It is not legally separate from its owner.
What does sole proprietor mean? How do you know what business to form as a sole proprietor? Let’s look at the advantages and disadvantages of this formation. Likewise, we will share when a sole proprietor may form an LLC.
Starting a Sole Proprietorship
Sole proprietors are low-risk. This means a business may start out unincorporated if it is low risk in nature. The same is true for businesses that require little investment to start up. You may name the business after yourself. Likewise, you may file for a doing business as name (DBA). This is a trade name under which you will do business.
This formation is affordable and requires little filing paperwork. The owner receives all the business profit. They will report all profits and losses on the individual’s tax return.
This individual may be their own boss. They have flexibility in the role to set their own hours. A sole proprietor spends time doing work they are passionate about. They may exercise full control as the business owner.
However, a sole proprietor also assumes full responsibility. This is responsibility for anything — good or bad — that may impact the business.
For example, let’s say there is business risk. A sole proprietor is an unincorporated business. As a result, it is not treated as a separate legal entity. As such, the owner, is personally responsible for any liabilities.
Types of Sole Proprietorships
Sole proprietors often begin as very small businesses. An entrepreneur may pursue a hobby they enjoy. For example, writing or photography. Consequently, these businesses often start with a small customer base.
Gradually, this hobby may grow its customer base, expand its offerings, and start to earn a profit. As soon as you start reporting your income to the IRS, this hobby officially engages in business activity. It then graduates into a sole proprietorship.
What are some types of hobbies that may eventually turn a profit? Here are a few examples:
- Writing. This includes ghostwriting, blogging, and freelancing for online outlets.
- Video blogging or streaming.
- Lawn care provider.
- Yoga instructor.
- Freelance professionals, which may include consultants, designers, writers, developers, and speakers.
Remember that a sole proprietor is usually a business with limited growth potential. It also has low overhead expenses. As the business grows its customer base and increases its profit, it will need to consider incorporating as a legal business structure.
Sole Proprietor Advantages
We understand what is a sole proprietor. Now, let’s review the advantages.
- Ideal for individuals that wish to exercise full control over their business.
- A good fit for low-risk small businesses.
- Easy to form and set up with little paperwork.
Sole Proprietor Disadvantages
Here are some of the disadvantages of starting a sole proprietorship.
- No limited liability protection. A sole proprietor is unincorporated. It is not legally separate from its owner. The owner’s personal assets may be at risk in the event of an unforeseen circumstance such as a lawsuit. These assets may include cars and houses.
- Taxes. Taxes are significantly more expensive. Incorporating a business provides tax benefits including the ability to elect an S Corp filing. This allows owners to avoid double taxation. However, a sole proprietor is considered self-employed. As such, they must pay both income tax and self-employment tax, which covers Social Security and Medicare obligations, each year. This may add up to an expensive tax bill.
- Funding difficulty. It will be difficult to raise capital, receive a loan, or interest inventors in an unincorporated business. Without a formal business structure, your sole proprietorship may be seen as unprofessional through the eyes of investors.
Should You Form an LLC?
It is possible to run an unincorporated business. As such, you may continue to act as a sole proprietor.
However, it may be wise to incorporate a business. This is helpful for business growth. Forming an LLC provides your business with limited liability protection. In conclusion, this ensures the business receives structure throughout its lifecycle.
Let MyCorporation assist you in forming an LLC. Visit us at mycorporation.com or call us at 877-692-6772 to incorporate today.