Sole proprietorships are the most straightforward business entities to establish. There are no registration requirements, ongoing responsibilities, or any financial costs involved. However, while it may sound like the best type of entity, there is a trade-off.
With 73% of small businesses in the U.S. classified as sole proprietorships, it makes sense to consider this structure for your next venture.
Let’s discuss how sole proprietorships work and whether they make sense for you.
Sole Proprietorship Explained
A sole proprietorship, or sole trader, is an unincorporated business entity. Unlike LLCs or corporations, sole traders are not considered separate business entities.
Due to this fact, no liability protections are in place, and any profits/losses are passed through directly to your tax return. You also lose the chance of succession planning and many tax mitigation strategies and may struggle to raise capital.
However, sole traders are perfect for entrepreneurs looking to test their ideas or run a small side hustle in their spare time.
Who Should Start a Sole Proprietorship?
All entrepreneurs should be looking to set a date for incorporation. The protections you get from running an incorporated business far outweigh the conveniences of operating a sole proprietorship.
Here are some examples of people who would benefit from a sole proprietorship:
- New Entrepreneurs – If you’re new to running your own business, freeing yourself of the filing and ongoing management requirements of an incorporated business structure can make sense.
- Seasonal Businesses – Small, seasonal businesses operating for a few months a year may not require the protections of an incorporated business structure.
- Low–Liability Firms – Some industries have higher liability risks than others. Firms in low-liability industries can often get by with a simple sole proprietorship.
The low costs of running an incorporated business, such as an LLC, meaning that even the above groups can benefit from incorporating. There is always a risk when doing business, and you need a strategy for protecting your personal assets.
Give serious thought to how long you continue to operate as a sole proprietor before taking the plunge and incorporating your business.
Unlimited Personal Liability
If you’re considering starting a sole proprietorship, the big issue is a liability. All incorporated businesses come with a degree of personal liability protection. In other words, if someone sues your business, they cannot go after your personal assets.
Sole proprietorships are not separate entities. Therefore, if your creditors come after you for outstanding debts or you are sued, all the costs must come out of your own pocket, including your personal assets.
You can defend against this problem partially by taking out insurance. Opting for comprehensive insurance for a sole proprietor will give you liability protection, meaning your insurer will cover the costs.
It still doesn’t provide you with the natural protections of an LLC or corporation, but it is a worthwhile investment if you prefer to operate as a sole trader.
How Do You Start a Sole Proprietorship?
Starting as a sole trader couldn’t be simpler. There are no requirements to register your business or pay any fees. Sole proprietorships are the default business option for all entrepreneurs who prefer not to incorporate.
However, you may still need to apply for business permits and licenses, depending on where you live and what type of business you are operating.
In short, there are no initial registration requirements and no ongoing fees to pay. The same requirements apply to every state in this respect.
Sole Proprietorship Survival Rates
With so many sole proprietorships in the country, what are the survival rates for these types of businesses?
Sadly, there are no specific figures recorded on sole proprietorship survival rates. However, the U.S. Small Business Administration (SBA) reports that half of all small businesses survive for five years or more, with a third of small businesses lasting ten years or more.
There is no established evidence to state that sole proprietors have lower survival rates than any other type of business.
Tax Considerations for a Sole Trader
Sole proprietorships pay income taxes by filing Schedule C and including the income from the business on their owners’ personal income tax returns. You will also need to calculate self-employment taxes. Since you are self-employed, you must pay out of your pocket.
All tax is reported as part of your personal income. Therefore, running a sole proprietorship could place you into an upper-income tax bracket if you already have a high income.
This is where the advantages of an incorporated business come to the fore. Corporations only pay taxes on any money retained within the business at the standard corporate income tax rate. Only distributions will be declared on your personal tax return.
Taxes are much more straightforward as a sole proprietor, but since they pass through to your personal tax return, you could be paying thousands of dollars more in taxes than you need to.
Make sure you speak to a tax attorney to learn more about the implications of launching a sole proprietorship. You may have reached a point where an incorporated business will save you thousands of dollars yearly on taxes.
Conclusion
Sole proprietorships are helpful for small business owners. With total flexibility on how you run your company and no incorporation fees to pay, there’s a reason why this is America’s favorite business setup.
Determining the best business structure for you requires research. Then, speak to a professional business attorney who can advise you on the right move for you and your brand.
What sort of business entity are you looking to launch?
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