Starting your own business sounds like The American Dream, right? Just the thought of it might make your mind wander to the freedoms of a flexible schedule or being your own boss. And yes, as a full-time freelance writer, I can attest that while there are times when this all feels like a dream, there are also times when it feels like The Most Confusing Thing Ever, so I sought some professional advice. I've mostly wondered if I should remain a sole proprietorship or if I needed to incorporate, and my accountant pointed out that since I'm a freelancer, I'm less of a business entity and more of a person who does business. All of this is to say that for my particular needs, a sole proprietorship is the best business structure for me.
I began my career as a full-time freelancer writer in March of 2016, and a year and a half later there's quite a bit that's changed for me. Not only do I now have a kid (!), but my business has shifted from half journalism work and half content marketing to being able to focus on food and drink writing almost exclusively. One thing that hasn’t changed, however, is my business model. If you’re facing the same decision for your own business venture, here are a few basics about sole proprietorships that will help point you in the right direction:
So, What Is A Sole Proprietorship?
It's actually fairly straightforward. A sole proprietorship is "a business ownership option in which the owner is personally responsible for the debts of the business," explains Ryan A. Woods, Esq. and founder of Where’s Legal?, P.C. law firm in Santa Monica, California. "It is not a 'legal entity' like an LLC or a corporation, and does business under the Social Security number of its owner."
Sounds simple enough, but Woods clarifies that "if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation," hence the confusion around the difference between a sole proprietorship and a limited liability company.
What Are The Pros?
"For really small enterprises — like Etsy stores with very few sales — that are in relatively low-risk markets, sole proprietorship is probably the way to go," recommends Brandon J. Huffman, Odin Law and Media. "It costs nothing and there is virtually no administration time or expense."
As an entrepreneur himself, Woods notes the benefit of maintaining decision-making power as a sole proprietor. "You are in complete control over your business ... because you are the business," he clarifies. "There’s also no corporate taxes or filings to worry about, and minimal legal costs to form your company, so you can get started right away."
As a freelance writer, I started as a sole proprietorship and I’m still one today. Choosing this business structure has been helpful, since I didn't have to jump through hoops to start my business — meaning I didn't have to file a ton of legal paperwork just to get my business off the ground. However, if my profits eventually grow high enough, it may be time for me to reconsider my business structure.
"If [a sole proprietor is] making less than $10,000 in profits for the year, then it makes no real tax sense to be anything other than a sole proprietor," explains Charles Read, C.P.A., U.S. Tax Court Practitioner, and President/CEO of GetPayroll. "However, if there is any chance at all of liability and being sued, then [sole proprietors should] form a separate entity to protect themselves and their family assets." Speaking of which...
What If I Get Sued?
Liability is possibly the biggest downside to sole proprietorships. "If your sole proprietorship gets sued, the financial liability is on you," explains Woods. "This means that your personal assets — bank account, houses, cars — aren’t protected. This is the biggest reason why its rarely a good idea to go into business as a sole proprietor."
If you are worried about litigation at all, you should strongly consider incorporating your business. However, even LLCs don’t provide 100 percent coverage, so additional liability insurance may be necessary to cover all your bases.
What Are The Cons?
Paying taxes every quarter was one of the biggest surprises I discovered when I started my business. Sole proprietorships may be able to file as an S corporation — many do, myself included — to legally save a few bucks.
One thing to keep in mind is that even if you file jointly with your partner, you are still obligated to file quarterly taxes. This is when a knowledgeable small business accountant will come in very handy.
Woods describes additional cons, namely "the lack of personal financial protection in the case of a law suit or business debt, as mentioned before. Also, you cannot take on investors, and risk losing 'business credibility' inherent in corporations or LLCs."
In some industries, there may be other businesses that require contractors to be formally incorporated. This is a bit of a gray area, and is a case-by-case basis. When you’re considering shifting into self-employment, familiarize yourself with who you plan to do business with and see if sole proprietorship is a deal-breaker.
This Sounds Like A Fit — Now What?
"To start a sole proprietorship, there are no formal legal steps required. You’re automatically a sole proprietor by just conducting your business," says Woods. While there's no mountain of paperwork to fill out to get started, there'll be some along the way (like W9s from clients), but your personal information and Social Security number is all that’s generally required. If you don’t want to use your Social Security number for your business, sign up for an Employer Identification Number online. It’s free and can be used in place of your SSN on business documents, including taxes.