Sole Proprietorship: Definition, Pros and Cons

What Is a Sole Proprietorship?

A sole proprietorship, additionally referred to as a sole tradership, individual entrepreneurship, or proprietorship, is a type of corporation controlled and operated by a single person with no legal distinction between the owner and the business organization. However, they do not always work alone and can recruit others.

Here are some key points you must know if you are considering forming a sole proprietorship for your new business. 

1. A sole proprietorship is an unregistered, unincorporated business conducted by only one person and does not distinguish between the owner and the company. Most companies you see around you, including your neighborhood grocer, pharmacy, and doctor, are usually run by a single person. 

2. A sole proprietorship lacks the legal separation from its owner that other business structures, such as partnerships or corporations, do. It is the most straightforward business organization for small enterprises and startups.

Characteristics of a Sole Proprietorship

Here’s a list of some defining characteristics of a sole proprietorship.

Single Ownership

• The defining characteristic of a sole proprietorship is that a single person owns it.
• The owner has complete control and decision-making authority over the business.

Unlimited Liability

• The sole proprietorship business's owner is liable indefinitely.
• The owner is personally responsible for covering any liabilities. They will be responsible for any debts if they obtain a loan for the firm.
• If there is inadequate money, the sole proprietor is personally responsible for any debt their estate can collect.

Simple Taxation

• One of a sole proprietorship's most significant benefits is the ease and simplicity of the tax system. For taxation purposes, a sole proprietorship is treated as a single entity, including the business and the owner. This indicates that the owner uses Schedule C (Form 1040) to include company income and expenses on their tax return. 
• Time and money are saved because there isn't a separate corporate tax return to submit.

No Legal Separation

• The business and the owner are considered the same in sole proprietorships, regarded by the law. This means there is no legal separation or distinction between the sole proprietor running the business and the business entity itself. As a result, the owner assumes complete control and responsibility for all aspects of the business.
• As a result, the owner is responsible for the business's debts and legal liabilities.

Ease of Formation

• To start a sole proprietorship is relatively easy and requires minimal legal formalities.
• The business usually starts as soon as the owner begins operations.

Ability to Hire Employees

• While the owners are the sole decision-makers, they can hire employees if the business requires an additional workforce.

How It Works

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In this section, we look into the detailed process of this widely preferred business structure and why it continues to be an appealing option for business owners. Undergo the necessary stages for establishing a solo business, from selecting and registering a business name to getting required permissions and licenses.

Registering a Company Name

When starting a small business, many entrepreneurs choose to be sole traders. As a sole trader, you have complete control over your business and its operations. It is a straightforward process to set up as a sole trader, thus making it an attractive option for those looking to launch their ventures quickly and on a low budget, depending on the industry or location, with minimal formalities. 

The first step towards starting a sole proprietorship is choosing a unique business name and ensuring it is not already used. The owner should register the business name per local regulations to avoid legal issues. 

Obtaining Necessary Permits and Licenses

Depending on the nature of the business and its location, the owner must obtain the necessary permits and licenses to operate legally. Compliance with local, state, and federal regulations is essential.

Opening a Business Bank Account

To keep personal and business finances separate, it is recommended to open a dedicated business bank account. This helps with financial organization and simplifies tax reporting. By opening a dedicated business bank account, the owner can effectively segregate financial transactions, making it easier to track expenses, manage cash flow, and simplify tax reporting. This financial organization lays the groundwork for long-term financial stability and accurate bookkeeping.

Hiring Employees if Necessary

The requirement for additional assistance becomes apparent when an organization grows and prospers. If the business grows and requires additional help, the owner can hire employees to assist in daily operations. 

Employing staff may reduce the owner's workload and increase production. To ensure the company’s success, it is essential to build a team with a relevant skillset and hire with the utmost consideration. Besides, creating a solid and cohesive team promotes an excellent work atmosphere and aids in effectively achieving business goals.

Maintaining Accurate Records

Keeping detailed and accurate income, expenses, and transaction records is crucial for tracking the business's financial health and simplifying tax filing.

Filing Taxes

It is essential to stay compliant with tax regulations to avoid penalties. As a sole proprietor, the owner must report their business income and expenses on Schedule C of their tax return (Form 1040).

Types of Sole Proprietorship

Despite being simple, sole proprietorships can have different types, each with unique benefits and drawbacks. The following are the types of sole proprietorships: 

An independent contractor: An Independent contractor works for companies or other, more well-known contractors for set pay rates or profit-sharing margins. An independent contractor retains the right to decline an engagement. Therefore, they are not an employee.

Self-Employed Owner: A self-employed owner runs their firm as the employer and the owner. A person who sells products through an online retailer is considered self-employed in this digital age. Although he owns his business, he needs to manage it daily like an employee. Some such examples are a painter and a store assistant.

Franchise: A franchise is also regarded as a type of sole proprietorship. The business owner chooses to lease a franchise from a well-known company and invests the necessary funds. The franchisee is required to pay the franchisor royalties. This business is an excellent foundation for new entrepreneurs since they can still rely on their franchisor's reputation even though they lack the knowledge necessary to manage a full-fledged company.

Pros and Cons of Sole Proprietorship

There are distinct benefits and drawbacks for a sole proprietor. When considering a sole proprietorship, it is critical to weigh these.

Pros of Sole Proprietorship

Simplicity: Sole proprietorships are easy and inexpensive to set up and manage.

Total Control: The owner has complete control over business decisions.

Tax Advantages: The business's income is taxed at the owner's individual tax rate, which can benefit certain businesses. The Tax Cuts and Jobs Act (TCJA) of 2017 reduced the corporate tax rate and ensured some relief for pass-through businesses. This allowed them to deduct up to 20% of eligible company income. If Congress doesn't renew it, the deduction expires on January 1, 2026, and can save you enormous money.

Flexibility: The owner can make quick decisions and adapt to market changes without extensive paperwork. You do not require an employer identification number (EIN) from the Internal Revenue Service (IRS), so filing taxes is easier. You don't need an EIN to pay taxes; instead, you may use your Social Security number (SSN).

Cons of Sole Proprietorship

Unlimited Liability: The owner's personal assets are at risk in case of business debts or legal liabilities. Companies with a history of success are preferred by banks, who often perceive borrowers with an insignificant balance sheet as high-risk borrowers. Getting equity from significant investors might be challenging as well.

Limited Resources: Because they primarily rely on personal savings or loans, a sole proprietor may have trouble generating financing.

Lack of Continuity: If the owner retires, is rendered unable to work, or dies, the company will no longer exist.

Limited Experience: A sole proprietorship may need to gain the necessary knowledge in some fields, which might limit its ability to expand.

Filing Taxes as a Sole Proprietor

As mentioned, the sole proprietor must report their business income and expenses on Schedule C of their tax return (Form 1040). To meet Social Security and Medicare obligations, they could also be required to pay self-employment taxes.

Sole Proprietorship vs. Self-employed

Although they are frequently used synonymously, "sole proprietorship" and "self-employed" differ. Working for oneself without being hired by another organization is what it means to be self-employed. On the other hand, a sole proprietorship is a particular kind of business structure where a single person owns and runs the business.

Here are the key differences:

Sole proprietorship:

• All obligations and liabilities of the company are the owner's personal responsibility.
• There is no legal separation between the owner and the business, making it the most straightforward and typical type of corporate ownership.
• A sole proprietorship's taxes are reported on the owner's personal tax return.

Self-employed:

• The term "self-employed" describes people who work for themselves and are not employed by a business or organization.
• Self-employed people can run their businesses as single proprietors or as members of a business or legal entity like partnerships or an LLC.
• They are free to decide how they want to run their business and how they want to plan their workdays.
• Since their employers do not withhold taxes from their salaries, self-employed people pay their taxes.

Difference Between Sole Proprietorship and Partnership

The key difference between sole proprietorship and partnership is the number of owners. The business structures of a sole proprietorship and a partnership are two distinct categories, each with specific traits and implications:

Sole proprietorship:

• Ownership: A sole proprietorship is a business owned and operated by only one person - sole proprietors.
• Liability: The owner's limitless personal sole proprietorship liability exists for all of the business's debts and contractual commitments. This implies that personal assets are vulnerable to corporate liabilities.
• Making decisions: The owner controls the business's operations and decision-making.
• Taxes: The owner must pay all business-related taxes, and business income is shown on the owner's personal tax return.

Partnership:

• Ownership: In a partnership, two or more people agree to split the business assets and liabilities equally and the earnings.
• Liability: In a general partnership, each partner is personally liable for all obligations incurred by the company. Limited partners, on the other hand, have a responsibility restricted to their investment, whereas general partners in a limited partnership may have limitless liability.
• Making decisions: Each partner's roles and obligations are outlined in the partnership agreement, and partners share decision-making authority.

Taxes: Partnerships must submit Form 1065, an informative tax return to record company revenue and costs. The partnership itself does not, however, have to pay taxes. Instead, gains and losses are passed through to each partner's tax return, and they each pay taxes on the portion of the partnership's income that pertains to them.

How Skuad Can Help

In conclusion, sole proprietorship stands as a highly favored yet slightly complex business form. Before deciding whether a sole proprietorship is the best choice, entrepreneurs and small business owners should carefully assess their business goals, risk tolerance, and scope. 

But what if we tell you that you can avail yourself of all the advantages of sole proprietorship without doing the groundwork? You heard us; when you partner with Skuad as your Employer of Record, we can do all the work for you—manage your global payroll, and provide seamless onboarding of foreign employees without having you establish a sole proprietorship or a separate legal entity in another country. 

Skuad is a leading platform that assists entrepreneurs, and small business owners in managing their global workforce. It gives you a stress-free way to extend their workforce and access to people anywhere, anytime by offering a seamless infrastructure that manages legal, regulatory, and payroll processes.

FAQs:

1. Should I Form a Limited Liability Company or a Sole Proprietorship?

Depending on your preferences and company needs. A sole proprietorship is easier to begin but provides no liability protection, whereas a limited liability company gives limited liability protection.

2. Do sole proprietors need an EIN?

Only sometimes, however, it is strongly suggested. You can also use your Social Security number for tax purposes, but an Employer Identification Number (EIN) can preserve your privacy and make commercial transactions easier.

3. Do sole proprietors need to file quarterly taxes?

Most of the time, sure. Typically, a sole proprietor must pay quarterly estimated tax payments.