What is a sole proprietor? When describing the different entity types, my clients often ask this question.
What is a Sole Proprietor?
A sole proprietor has one owner. It exists without papers filed with any government. It has unlimited liability for the owner. Consequently, it is the cheapest and easiest way to start a business.
If you were to have two or more owners, you would have a partnership. They operate similarly as far as liability and tax consequences are concerned.
You do not need to file any startup paperwork with the state because this is the default entity type when you don’t file. However, the filed entity types are more protective and have better tax benefits.
There is no difference between an individual and their company in this legal setup. Combining your personal and business bank accounts will not add extra liability at all. You’re already 100% personally liable. Everything the business does, you’re deemed to be the one doing it. This includes employees!
Ever complete a 1040? That’s your business taxes too now. You’ll have to complete a couple extra schedules, but it’s the same tax filing for sole proprietors.
Common Myths About the Sole Proprietor
Here are some common myths I encounter about sole proprietors:
- Filing a DBA protects you from liability like an LLC. False. Only filing Articles with the Secretary of State will protect you personally.
- Sole Proprietors must use their social security number. False. You can obtain an EIN from the IRS for free even as a sole proprietor.
- Sole proprietors don’t need business licenses. False. Anyone operating any business must obtain the appropriate business licenses in their locality.
- No one should use a sole proprietorship. In some fields, this entity type makes financial and liability sense. For example, some professionals operate this way. It makes sense when you cannot remove the liability in the same way as other industries. Realtors are commonly sole proprietors.
- You can’t have employees. False. You can have employees. However, I do not recommend it.
- Your business doesn’t start until you file. Untrue. There are many moments that your business could “start.” If you were planning on starting as an LLC but you’ve spent money beforehand, you may be a sole proprietor initially. That’s why it is important to file before taking any substantial step.
There are lots of reasons to avoid sole proprietors, and very few reasons to operate as one. However, sometimes, it is accidental or unavoidable. The trick is to have the entity type that provides you with the most personal protection and best tax outcome. Sometimes that is the sole proprietor.