How to Form a Sole Proprietorship

By Cameron McCool on January 19, 2017

Heads up: this article is only relevant for U.S. businesses.

The sole proprietorship business structure is a popular choice among new business owners because of how simple and affordable it is to get started.

Once you’ve conducted a business activity, you’re already operating a sole proprietorship—but there are a few extra details you’ll need to take care of to satisfy the IRS.

How to establish a sole proprietorship

Thankfully, setting up a sole proprietorship is easy—no legal documents need to be filed to form this business type. You simply start your business.

Depending on the nature of your business and the industry you’re in, you may need to consider a few additional steps before you get up and running.

Business vs hobby

Generally, any activity is defined as “a business” when it’s clear that you are intending to make a profit from that activity. For example, if you sell handmade birds’ nests out of your garage—but you’re not covering your material costs—this is probably a hobby, not a business. On the other hand, if you’re making a tidy profit from each sale, it’s likely that you’re running a business.

Business insurance

Make sure you have the right insurance to shield you and your business from unforeseen disasters and legal issues.

Licenses and permits

You may also need to ensure you have all of the proper licenses and permits lined up to satisfy the state. The necessary paperwork here will depend largely on your region and your industry. Visit the Small Business Association’s Business License and Permits directory for more information on acquiring the correct business license.

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Sole proprietors enjoy total ownership

Ownership is total when you are the sole proprietor, meaning you are free to make decisions and changes as you see fit. When you’re the one in charge, you don’t need to consult a board of directors, partners, or shareholders. For many, this freedom is what makes the sole proprietorship business structure so appealing.

Sole proprietors accept personal liability

The advantages of total ownership is offset by the unlimited personal liability that comes with running a sole proprietorship. Legally, the business owner and the business are considered to be one and the same—meaning that the owner of a sole proprietorship can be held personally responsible for any money owed by the business.

For example, if your business is saddled with a $2 million debt, the IRS could potentially seize your personal assets to cover that debt. This could include your bank accounts, retirement funds, your home, and other personal assets. This is a crucial aspect to consider when deciding on the structure of your business.

How to pay taxes as a sole proprietor

Filing taxes as a sole proprietor is fairly straightforward. Business earnings (or losses) are reported directly on Schedule C of your personal income tax return. Income from the sole proprietorship is taxed at the owner’s (your) personal rate.

Tax tasks you might need to address include:

The good news is, if your business outgrows the benefits of this business structure, you can transition your sole proprietorship to an LLC.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.

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