The notion of chucking the corporate career and going it alone as the owner of a small company is certainly taking hold across the fruited plains.
According to data from FreshBooks, approximately 27 million Americans will walk away from their full-time jobs from now through 2020, resulting in 42 million self-employed U.S. adults by that time.
Whether you want to build and sell surf boards or design cool new mobile apps for a living, hanging your "open for business" sign outside your front door shows the world that you're not afraid of risk, and want to live life (at least your career life) by your own rules.
Aside from hanging that sign, the first step in that process is deciding how to establish your business, category-wise.
While there are several business categories to consider, most self-employed people prefer to establish sole - or individual - proprietorships. As a sole proprietorship, you are the business and therefore responsible for all debits and credits associated with it.
Put another way, your name is going to go on that tax form line where your previous employer's name used to be.
What Is a Sole Proprietorship?
A sole proprietorship is exactly what the first word in the term implies - you run the show and are the legal owner of the business, so you accept all assets and liabilities of owning the business.
That doesn't mean the business has to bear your name on the front door. Your company can be named after you, or have a different name (like "Sam's Surfboards" or "Wanda's Web Designs.") Your company name is viewed by the government as a legal entity that is completely separate and distinct from the owner of the sole proprietorship.
Sole proprietorships are widely viewed as the simplest and easiest small business categories. They're easy to set up, don't cost much to do so, and suffer no undue regulatory intervention, unless the business makes some big mistakes later on down the road.
Tax-wise, sole proprietors prepare their taxes on Schedule C, which is attached to the IRS 1040 tax form. As mentioned above, most sole proprietors file under their own name. If your name isn't very marketable and you're instead selling surfboards as "Sam's Surfboards," that's OK, too. Just file a "doing business as" (DBA) form with your local tax assessment office or municipal documents office.
As a sole proprietor, you can either pay taxes on an estimated basis or just at a single time, on your personal income tax return. Your tax bill will be based on the income your sole proprietorship earns. For instance, if your business makes $75,000 annually, you pay taxes based on the $75,000, regardless of any expenses that meet or even exceed that amount.
How to Set Up a Sole Proprietorship
Take these steps to establish your business as a sole proprietorship:
1. Choose a business name
Again, it does not have to be your own name, or even have any part of your name in it. Don't name it after another company, though. That could lead to trademark infringement troubles and the last thing you need when opening a new business is an error like this.
2. File with the state
File your business/name with your state's Secretary of State Office or comparable small business office (sole proprietorship sign-up rules can vary from state to state).
3. Get your necessary licenses and permits
Depending on the business you're operating, you might need specific licenses, permits and zoning clearances to get the blessing of your state government. Most states, via their Secretary of State office and web site, offer a comprehensive listing of every type of business and occupation, and the various documents they need to open for business. Local ordinances, especially pertaining to zoning issues and building permits, might be in play, too. Check with your local city or town clerk's office to see what and if you need any special permits.
4. Get an employer identification number
In most states, sole proprietors who wish to hire employees must obtain an employer identification number (EIN). This is a tax-related mandate, as the EIN identifies you when any employee, and when you as a business, submit your tax returns. If you don't hire employees, file with your Social Security number, instead.
5. Open bank account
Once you have established your business as a sole proprietorship, it's a good idea to open a bank account in your business's name (to keep your company money walled off from your personal bank account), buy some good general liability insurance, to protect you from unexpected, negative financial events, and check with your state's tax office to see if there are any other mandated taxes linked to your new business.
Advantages of a Sole Proprietorship
There are multiple and distinct benefits of being a sole proprietor. These advantages top that list:
- They're easy to open. A sole proprietorship really doesn't require a lot of paperwork and red tape. You can easily open one inside a single business day.
- Tax advantages. There are myriad write-offs you can take as a sole proprietor, including health care insurance, travel, equipment and hiring/staffing write-offs. With the new tax laws, certain sole proprietors may qualify for a 20% small business deduction. Check with your accountant to see if your business qualifies. (Yes, you should have a good accountant as a sole proprietor.)
- You're the boss. As a sole proprietor, you call the shots, keep all of the money earned from the business, minus taxes, expenses and salary incurred, and set your own hours.
- Start-up costs are low. Past setting up your office or business (including fees, rent and equipment), starting a sole proprietorship is very inexpensive to do - and most of those expenses can be written off for taxes.
- Ending your business is easy, too. If worse comes to worse, and your business doesn't add up financially, you can easily close it down, at little expense.
Disadvantages of a Sole Proprietorship
Operating a new business as a sole proprietorship isn't all sugar and spice - you'll need to factor in these potential disadvantages:
- Any debts are your debts. Any debts or financial liabilities incurred in the operation of your sole proprietorship are your debt, and yours alone. No employer is going to swoop in and help you out if your business falls $100,000 in debt.
- You are the boss, Part II. Yes, you are the boss, with all the advantages that entails. But as the boss, it will be up to you make the key decisions with your business - for good and for bad.
- Your working hours could be off the charts. Fledgling businesses require a great deal of care and nurturing. To get your sole proprietorship off the ground, be prepared to work plenty of nights, weekend and holidays to optimize your chances of business success.
- Tax penalties. Since you're no longer a corporate employee, it's up to you to handle all of your taxes, and it's up to you to pay 100% of your FICA/Social Security tax. (As a corporate employee, your employer pays half of your Social Security tax.)
Famous Businesses That Started as Sole Proprietorships
When you start out as a sole proprietor, you're in good company. Check out these familiar names that started out as sole proprietors, too.
- eBay. Pierre Omidyar, founder of the online retail giant eBay, started as a sole proprietor, reportedly because he wasn't sure his business was going to make it big. Omidyar went from a sole proprietor business model to going public and earning millions, all in three short years.
- Kinkos. Paul Orfelea, founder of Kinkos, rolled out his line of small business services shops as a sole proprietorship, and kept it that way as he expanded to 450 shops. When Orfelea finally sold out, Kinkos was still a sole proprietorship.
- Annie's Homegrown. What you know today as Annie's Homegrown, make of the Smartfood line of gourmet snacks and meals, started out as a sole proprietorship, too. Founder Ann Withey kept her company as a sole proprietorship well after it found financial success, mostly because she liked the continued flexibility it provided.
Corporation vs. Sole Proprietorship
If the life of a sole proprietor doesn't sound good to you, you can establish your new business as a corporation.
Unlike a sole proprietorship, where you are essentially the business, a corporation is a legally recognized entity that includes all of your business's assets, debts, expenses and revenues (but not "you"). If you have a good-sized business starting out, and you already have a plenty of staffers already on board, corporation status may be a better option due to its limited liability advantages. In other words, as a corporation, you're protected if the bottom falls out and your secretary flees to Hawaii after emptying your business bank account. In that type of disaster scenario, courts hold the party that's responsible for any wrong doing as the guilty party, and doesn't hold you responsible.
That said, be careful about corporations. Going the corporate route is way more complicated than sole proprietorships, especially since you're liable for twice the amount of taxation. That's due to the fact that corporation's income is taxed twice, the second being on dividends paid out of earnings.