Small Business 101: Starting a Small Business as a Sole Proprietor

by Diva Shannon

Starting a Business as a Sole ProprietorFor many, the American Dream includes starting a small business. One of the first steps toward the dream is to decide what legal form your business will take.

The simplest structure, and therefore most popular, is a sole proprietorship. Yes, it may be the most difficult to pronounce and spell, but it is the simplest legally!

You do not have to file legal papers to become a sole proprietor. If you are doing business and you do not have another type of legal structure, you are considered a sole proprietor. About 70 percent of businesses in the U.S. are sole proprietorships.

However, like any other business, you must file for the proper licenses/permits required by your state and local governments when starting a small business, as well as any industry requirement. Every state and locality has their own rules about what you need to file.

If you are not operating under your given name, you will likely have to file a fictitious name, trade name, or “doing business as” (also known as a DBA) with your state government. It is important to do some research for your business name to ensure you are not infringing on a trademark or another business name. You will need the paperwork from this filing in order to open a bank account under your business name. You may also need the proper local certifications.

In some areas, you need to file with the state, then county, then city. In other places, the city comes before the county. But, you will usually need to start with the state, even if you are operating under your own name.

One of the easiest ways to find out the laws in your area is to call your bank and ask them what you need to open a business account. Many state and local governments now have information online. Also, your local Small Business Development Center (part of the federal Small Business Administration) can help you sort out the local regulations. Their assistance is free and they are located throughout the country. Visit sba.gov and click on Local Assistance. There is an interactive map to help you find your local resources.

As a sole proprietor, you will be paying taxes on your overall earnings. However, you will be deducting your business expenses from those earnings, according to the federal, state, and local tax codes. Your “salary” as a sole proprietor is not considered a business expense and you don’t have to decide what your salary will be in advance.

Since you won’t be paid as an employee, no income tax will be deducted from whatever you withdraw your business earnings.  What you’ll have to do is file an estimated tax return (and possibly pay estimated taxes) on a quarterly basis. Check with the IRS for Publication 334, Tax Guide for Small Business. An accountant or bookkeeper is very helpful for estimating taxes and understanding the complex system for what you might need to pay quarterly.

Here are a few of the advantages to consider when starting a small business as a sole proprietor:

It is the easiest and least expensive business structure to start. Legal costs are minimal.

You have full control over all business decisions. You don’t have to consult a partner or shareholders on decisions or changes you want to make.

Tax preparation is not significantly more cumbersome than filing your regular income tax. You will use a Schedule C to report your income/loss to the IRS, and most states have similar forms or use your federal information. You will need to file an extra form if you have a profit to report and pay self-employment taxes.

Here are a few of the disadvantages to consider when starting a small business as a sole proprietor:

Your personal assets are more at risk as a sole proprietor. Because there is no legal separation between you and your business, you can be help personally liable for the debts or other obligations and that includes liability for any legal actions.

It can be more difficult to raise money as a sole proprietor because you cannot sell stock to investors and banks may be more reluctant to lend money to a sole proprietor.

Next up: Small Business 101: What is a C Corporation?

About the Small Business 101 Series from Small Business Divas

There is plenty of expert advice on small business available, but often the basic questions aren’t answered. And for someone new to a subject, it’s difficult to understand the information without a good understanding of the basics. The Small Business 101 Series is all about the basics: what, why and how.

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