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Everything You Need to Know About Sole Proprietorship
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Everything You Need to Know About Sole Proprietorship
Being a freelancer or self-employed individual means you’re usually the only person responsible for your work most of the time. You have to handle a variety of tasks including dealing with clients, delivering the job and managing your time and different assignments simultaneously. Running all these tasks together means you’re working more as a business than an individual. Which leads us to the topic of sole proprietor, essentially meaning you’re a self-employed individual.
But there's more to sole proprietorship, as it can be considered the stepping stone for your future business if you ever decide to expand it with a larger team. The idea is to onboard individuals with minimal paperwork. A sole proprietorship has some advantages and disadvantages, which we'll discuss in detail.
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What is a sole proprietorship?
The IRS recognizes a sole proprietor as a person who owns an unregistered or unincorporated business, called a sole proprietorship. The business owner is also the only employee and has the liberty to make decisions on the business's behalf. This person is also responsible for paying personal taxes and taking care of other business liabilities.
The IRS has several forms that help you file your taxes for your sole proprietorship. In addition, because a sole proprietorship has a single owner, it can operate under the owner's name, unlike other larger business entities like LLC, S-Corp or C-Corp.
A sole proprietorship is also much easier to assemble and dissolve. The owner of a sole proprietorship doesn't need much paperwork or government involvement or the need to seek the approval of multiple partners in a partnership.
A few examples of a sole proprietorship include:
- Make-up artists
- Individual graphic designers
- Freelance social media managers
- Self-employed camera operators
What are sole proprietorship taxes?
It can be defined as the taxes a sole proprietor pays on the profit from running a business. It's a regular income tax that the individual owner of the proprietorship pays on any income arising from his/her business activities. All the profits of the business flow directly to the owner.
To file for the sole proprietorship taxes, the business owners need to keep track of a few IRS forms like Form 1040, Schedule C, etc.
What are the advantages of a sole proprietorship?
The most significant advantage is the simplicity of creating a sole proprietorship. It takes minimal or no paperwork in most U.S. states. The idea is to promote the ethos of entrepreneurship and enable the population to start a business easily.
With minimal paperwork, your business can switch gears quickly since you don't need to worry about filling out lengthy forms and an extensive registration process. For a sole proprietorship, you don't need to apply for an employee identification number (EIN) with the IRS as you are the only employee. But, certain kinds of businesses require special licenses, so you might need to apply for one. For example, if you’re a freelance delivery driver for an application like Postmates, Uber or Lyft, the bare minimum requirement is a U.S. driving license.
A sole proprietorship also has minimal fees and cost of setup. In addition, you can make business decisions independently on your own since it’s under your sole ownership.
What are the disadvantages of a sole proprietorship?
The major disadvantage of a sole proprietorship is that you are liable for all the debts of the business. Also, you have to take care of all the losses alone, unlike a partnership, where you can have multiple partners dividing the profits and the losses. On the other hand, a sole proprietorship comes with unlimited liability, where the debt and losses go beyond the business and directly to the owner.
In a sole proprietorship, you are responsible for all the business liabilities. Unlike a large corporation, you'll have to take care of all the business's tax filings. As a sole proprietor, you also cannot have employees.
As a sole proprietorship, it isn't easy to get capital funding, give out business equity or obtain a business loan or credit. For instance, if you receive bank credit from a large bank or investor, a sole proprietorship has no protection from the state against the creditors. On the other hand, if you have an LLC, you have some protection against creditors. The creditors can seize your personal property as collateral if you default on the repayment or the business fails in a sole proprietorship.
When we consider large banks, they usually require a proper track record to sanction a loan or credit. Plus, banks look out for companies with stable teams.
In most cases, the business ends if – unfortunately – the owner can no longer continue the work or has passed away.
How to file sole proprietorship taxes?
There are a few forms needed to file taxes as a sole proprietor. You just need to fill in Form 1040 to file your taxes and the Schedule C to declare your profits and losses.
If you are a sole proprietor and a senior citizen, you must fill in 1040-SR, which will allow you to save more on your taxes. As a self-employed person, you also need to fill in the Schedule-SE on Form 1040.
You need to fill out these basic forms to file your taxes, but you can refer to the IRS to check if certain specific taxes apply to you.
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