With the rise of side hustles and finding ways to earn passive income, many people want to know how to professionalize themselves further. Instead of starting a small business as an LLC or corporation, many are opting for a sole proprietorship.
Aside from legitimizing a side hustle, sole proprietorships can help you ease into business ownership—while retaining the ability to scale if and when you’re ready.
What is a Sole Proprietorship?
A sole proprietorship is an unincorporated business that normally consists of an individual providing services to other people. Sole proprietorships have no employees and all of the money they make is part of their personal income.
Sole proprietorships allow you to classify your freelance work, independent contracting, consulting work, or more as an individually-owned business. A sole proprietorship can bear the name of the individual owner or a made-up name, in case the individual wants to separate their contract work from other work.
A sole proprietorship is not like an LLC (limited liability corporation) in that it is not a separate legal entity from the individual. However, many sole proprietorships will end up turning them into an LLC later on when they’re ready to scale up. Sole proprietorships can either be a long-term way to classify your individual work, or a first step toward building a business.
The reason a sole proprietorship is smart to set up is because there are no costs or approval processes unless you’re opting to use a name for your business that isn’t related to your legal name. In which case, you’ll only need to register your fictitious business name (aka FBN) typically with your county clerk or Secretary of State office.
If the services you provide don’t require a license, you can get started immediately. Whatever kind of services you’re providing, if you’re doing them as an individual, the sole proprietor classification makes it easy to get started.
How Does a Sole Proprietorship Work?
Sole proprietorships don’t require any upfront paperwork. The designation is automatic and kicks in as soon as you start doing business.
If you start taking on freelance contracts, for example, you are now working as a sole proprietor. And you and your business are one and the same. Because of the simple nature of sole proprietorships, they’re the most common form of business in the U.S.
Sole proprietors may choose to convert their small businesses to LLCs or corporations, but they also might keep their side hustle as a sole proprietorship for as long as they work on it.
If it’s just a side hustle outside of your regular employment, there’s no need to file LLC paperwork and pay fees to keep it up. Sticking with small contracts and filing taxes as a sole proprietor is enough for freelancers like web designers, small crafters on Etsy, or personal trainers.
Taxes
Instead of having taxes taken out of your paycheck regularly, as a sole proprietor, you’re responsible for paying your own self-employment taxes. Many sole proprietors choose to pay estimates on their self-employment income quarterly in order to avoid a massive tax bill in April of the next year.
When filing your personal tax return (Form 1040), you’ll need to use a schedule SE form to determine the self-employment taxes you owe and a schedule C form to report your business’s profits or losses.
Pros and Cons of a Sole Proprietorship
Pros
Since you don’t have to pay any startup fees, a sole proprietorship is an incredibly easy way to start a new business. There is no filing process—you can start offering services as an individual without incorporating.
Since it’s easy and inexpensive to set up, you can quickly legitimize your side hustle. If you have a candle making hobby, you can ask around local stores to see if they’re interested in selling items from local artisans. If you want to continue this process as a sole proprietor for a long time, you won’t have any business operating costs or filing duties. It’s easy to transition your sole proprietorship into an LLC or a corporation once you start making money and proving yourself in your chosen field.
Keeping track of expenses is important in a sole proprietorship so you can list them as business expenses. If you operate your business out of your home, there are some home costs that can apply to the sole proprietorship. Some people find it easier to avoid starting new bank accounts for their business and keep everything in one place. You are not required to open a separate account, but having a separate checking account for business expenses and income could help you keep track of everything more easily. You are also able to deduct business losses from your personal income.
Cons
Liability is the biggest con to keep yourself aware of. If you take a loan to cover your startup costs (buying technology and various other resources to start providing services), you are responsible personally for paying back that loan. There are various ways the sole proprietorship could not work out, so the loan would be a huge imposition to pay back.
In the event your business is involved in a lawsuit because of an accident or another issue, the owner of the sole proprietor is the responsible party. Your personal assets are fair game in a lawsuit against you as a sole proprietor. If you’re involved in an accident during the course of business, there is no divide between the individual and the business.
Determine if a Sole Proprietorship Right for You
A sole proprietorship is ideal if you want to dip your toes into the waters of entrepreneurship. There are no major upfront costs, and you’re only responsible to yourself for the continued operation of the business.
Many people with sole proprietorships eventually transition them into LLCs, LLPs or corporations. But that’s not a requirement.
On the other hand, if you already have a very strong business plan and general outline, you might be better off taking the big plunge and starting your business as an LLC or corporation. By taking that risk, you’ll be able to mitigate your personal financial responsibility.
Ultimately, a sole proprietorship is best for you when you have an idea and want to start immediately.
