Sole Proprietorship Business Structure Easy to Form
A sole proprietorship is the simplest form of business structure in the United States. It’s also the most dangerous form of business structure. It is easy to start a sole proprietorship, because all you have to do is decide you want to do business, and you’re a sole proprietorship. You don’t have to file any paperwork with the state, like you do if you are setting up a corporation or limited liability company (LLC). You don’t have to get a tax number from the IRS. All you have to do is decide you want to do business in some way.
There isn’t any such thing as a sole proprietorship “agreement” or by laws. There is no paperwork. All you need to do is have the intent to make money, and you are are a sole proprietorship.
Sole Proprietorship Dangerous to Operate
Sole proprietorships are “dangerous” because you are personally liable for all of the liabilities that come with doing business. In order to encourage people to set up small businesses, congress created statutory protections for the business owners. They created the “corporate shield” which protects the business owners and investors from the liabilities associated with operating the business. A sole proprietorship doesn’t have any type of protection for the “owner” — you.
Note that if you have another person involved in the business in any way, then you’re not a sole proprietorship. By definition, you are a “partnership.” That’s even more dangerous than a sole proprietorship, because in a partnership you’re not only liable for what you do in the business, you’re also liable for what the other guy does. Never place yourself in a position where you are liable for what another person does.
The problem is you can get into a partnership very innocently when you think you are a sole proprietorship. As soon as you involve another person in your business in any way (other than a hired employee with an employee contract) you then have a partner. In fact, you don’t even have to think that you have a “business.” All you have to do is be doing something with someone with the intent to make money (whether or not any money is actually made), and you are in a partnership.
If you lend someone money to do something that could make money, then you have just entered into a partnership agreement, and you are liable for whatever they do. Of course, if you make the other person sign a note and go through all the “money lending” steps and paperwork like a bank would put you through, if they loaned you money, then you’re not a partner; you’re a lender. If there isn’t any loan documentation, then by law you’re a partner.
Advantages of a Sole Proprietorship
The advantages are (1) the ease in establishing – you just start doing your business, and (2) the ease of tax filing.
Taxes are easy. You will simply file your normal 1040 form and include a Schedule C that attaches to the 1040. Use your Social Security number when you are asked for any type of a business tax number. The sole proprietorship gives you some significant tax advantages, because whatever happens on Schedule C affects your adjusted gross income, and any company, including a sole proprietorship, can take advantage of tax laws that you can’t take advantage of as an individual tax payer.
Your little business, whether it is a sole proprietorship or any other type of business structure, is the best bet you have to save taxes and take more money home to spend.
Reserve a Name for Your Sole Proprietorship
Most of the time, a sole proprietorship will be “operated” under the name of the sole proprietor. However, you can reserve a DBA (Doing Business As) name with the state where you are doing business. Click HERE for more state information. Each state has a website where you can go to check to see if the name you want is available. If it is available, the fees for reserving the name are relatively small. If you think you will eventually form an LLC or corporation, then you should reserve the name you want for your company and start doing business under that name. It would be a shame to get a couple of years down the road and have established a business under a specific name and then learn that the name wasn’t available to you. If somebody else gets the name reserved with the state, you’ll have to stop doing business under that name.
Today, it is very important to see if the name of your business is available in cyber space. You will need a domain name that matches your business name or at least a domain name that has some relevance to your business. You can check out domain name availability at www.Whois.com or a site like www.godaddy.com.
Get Asset Protection and the Tax Advantages of a Sole Proprietorship
An LLC is a unique animal in the law, because it has the corporate shield, just like a corporation, and it can be taxed as a sole proprietorship if there is only one owner. If there are two or more owners the business venture will be taxed as a partnership, unless you file with the state as a corporation or LLC. You can be a single member LLC and choose to be taxed as a corporation (C or S). Yes, there is the hassle of setting up the corporation or LLC entity with your state, but in my opinion, the asset protection value of the formal entity far outweighs the trouble and expense of setting up the entity structure.
Obviously, if you are doing some sort of business activity with a very limited liability exposure, then a sole proprietorship is just fine. You don’t need an LLC or any formal business structure. Let’s say you are knitting handkerchiefs and selling them on eBay, that’s pretty low liability, and there isn’t any need to use an LLC or corporation. Just use a sole proprietorship.
There are some states where the state filing fees make you think twice before setting up an LLC or corporation. California runs about $800 per year just in state fees. New York has a funny (not really so funny) law that you have to publish in the main papers your intent to set up an LLC. That can run several thousand dollars, and then to top it off, the annual fees are high. New Jersey is high, but most states are quite reasonable. In Arizona for example, there is a modest fee to set up the LLC and then no annual fees.
Check the State Fees
You need to establish your LLC in the state where you are doing business. Don’t fall for the “Do your LLC in Nevada” type hype. Even if you set up an LLC in Nevada or Delaware, or Colorado, or New Mexico, or… or… or… you will still have to register your LLC in the state where you are doing business, and you will pay all the state fees just like you would if you set up the LLC there in the first place.
A Nevada LLC won’t give you any more asset protection. You will still pay taxes in the state where you earn money, not in Nevada (or whatever state). You will have to pay state fees (about $350 per year) in Nevada, plus you’ll have to pay the registered agent fees, etc, etc.
The asset protection advantages of operating as an LLC are usually worth the extra cost and hassle of establishing and maintaining the LLC. My knee jerk reaction today is to tell you to use an LLC instead of a corporation, because you can get double the asset protection out of an LLC as you can a corporation. Yes, an LLC has to follow the corporate formalities if you want the corporate shield protection, in spite of what people say or even what your state laws may say. Practically speaking, when you get sued the court is going to look and see if you did the formalities. If you haven’t followed the corporate formalities, the judge will call your company an “alter ego” and set aside your asset protection shields. He will “pierce the corporate veil,” and suddenly you’ll be personally liable for all the business problems.
Before you start doing business, or even if you’re already doing business, you need to learn about the positives and negatives of the business structure you use. A sole proprietorship structure is ok in some cases, but it isn’t good if there is any liability exposure in your business activities. My first suggestion is to look at an LLC.