Thursday, November 17, 2022

How Does A Sole Proprietorship Work

Llc Vs Sole Proprietorship

How a Sole Proprietorship Works | Introduction to Legal Structures

A sole proprietor has total personal liability for their organization. The owner can use private funds to offset business loans and expenses. Even when you sell the business, you are still responsible for the debt incurred during your tenure as the business owner.

In case of death, the deceaseds estate is used to settle all business deficits before its remainder is handed over to successors.

Additionally, in a proprietorship, the owner is liable for business legal issues. For example, when their company is in debt, the proprietor must first file for personal bankruptcy after liquidating business assets.

Only then can they request a discharge from the remaining business debt. This is where LLCs have the upper hand in the LLC vs. sole proprietorship battle:

LLC owners have limited liability protection because the organization is a separate legal entity. Both single-member and partner organizations get their personal assets shielded from liabilities relating to the company. However, in certain conditions, multiple LCC owners shoulder the companys liabilities:

  • An owner participates in fraudulent activities or other unlawful business ventures.
  • An owner participates in legal ventures that infringe on the distinction between personal and business transactions. For instance, when they co-sign or secure a business loan.
  • An owner absconds their fiduciary duty for personal gain.

Theres No Limit To The Number Of People You Can Hire

There is no limit to the number of people you can employ as a sole proprietor, and this allows you to grow your reach and your team without taking the leap to formally incorporating your business.

There are risks associated with this as the owner of a sole proprietorship, you are personally liable for the well-being and payment of your employees . However, when youre fighting to get your business off the ground, the freedom to hire top talent as soon as you canwhenever theyre available and without any adjustments to your business structureis highly advantageous. Often, these collaborators can emerge unexpectedly and help you in ways you may not have considered.

Once youve made the leap , its amazing how resourceful you become, says Kirk Reynolds, founder and president of guide company Discover Outdoors, to Ideas by WeWork. Youll find there are people who want to help you, so you wont be alone. Also, dont wait until you have everything perfectly planned. That day will never come.

Disadvantages Of Sole Proprietorships

  • Owners are completely responsible. If business debts become overwhelming, the individual owners finances will be affected. When a sole proprietorship is unable to pay its debts, the owners home, savings, and other personal assets can be used to fulfill those debts.
  • Self-employment taxes apply to sole proprietorships. Owners must pay self-employment taxes on business revenue.
  • Business action ends with the death or departure of the owner. Because the owner and the sole proprietor alone owns a business, if the owner dies or becomes disabled then the business dissolves with them and the capital and assets of the business become part of the personal estate. The assets and property are subjected to inheritance taxes and can have a big impact on workers of the sole proprietorship.
  • Collecting capital is a challenging task. Initial funds of the business are made by the owner and raising funds for the business can be difficult since they cannot issue stocks or other investment income. Loans may also be challenging if the owner does not have enough assets to protect additional money.
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    When To Use A Registered Agent Service

    Many small business owners act as their own registered agent or name a friend, family member, or employee. It saves money, but its not always a good idea. When choosing a registered agent, there are several reasons to pay for a registered agent service instead:

    • Privacy. If you or an employee is the registered agent, you risk the embarrassment of having a legal action served in front of customers, clients, or co-workers. Also, the agents address is public record, a potential concern if you have a home-based business or are planning to name your spouse as your agent.
    • Consistency. If you list an individual as the registered agent, youll need to update your registered agent information if there are any changes to the persons identity or address. Few small business owners remember to do this, but if you fail to maintain a registered agent, your business can lose its good standing with the state.
    • Knowing the job will be done right. Registered agent services are experienced and professional, making it more likely that important documents will quickly get into the right hands.
    • Multiple states. If you do business in more than one state, multiple registered agents can be a hassle. A service can act as your agent in multiple locations.

    Choosing a registered agent may seem like a minor issue when youre starting a new business. But an agent serves an important role. Be sure your agent meets your needs and can do the job promptly and professionally.

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    A limited liability company operates similarly to a sole proprietorship. If you are the only owner, you have complete control of the company. But, unlike a sole proprietorship, you can also share ownership of the LLC with another person.

    The LLC business entity protects you from personal liability. In terms of taxes, itâs a separate entity. It has its own business debts, can be sued, and can file for bankruptcy.

    An LLC takes more work than a sole proprietorship to set up. And there are also fees involvedâabout $1,000 worth, on average. If youâre interested in this business structure, learn more about how to transition from a sole proprietorship to an LLC.

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    You Have Complete Control As The Owner

    Sole proprietorships are automatically tied to you personally, and this gives you complete control over the company and its trajectory. There is no need to make decisions based on the wants of shareholders or the requirements of legal partners. You can pivot your strategy as needed, and take your startup in any direction you wish to grow.

    This freedom means sole proprietorships are a popular first-step in building a business, as the structure gives owners the flexibility to experiment before committing to the regulations involved in operating a Limited Liability Company or a corporation.

    Sushi delivery restaurant Zoku Sushi, for example, began operations in São Paulo, Brazil, with a small-scale test market. This starting point allowed the companys founder, Charlie Yi, to test the concept and build the necessary technology before launching a delivery-only restaurant in New York. This level of testingat any location, with any iteration of your productis easier with a sole proprietorship compared to other business structures that require formal registration with local government.

    What Is An Independent Contractor

    Independent contractors are also self-employed individuals who provide services to clients and corporations but are not employees. An independent contractor receives payment based on the work they do. They may be paid by the hour or per project, depending on the terms of their contract. Companies that hire independent contractors do not withhold payroll taxes from their pay unless the contractors are subject to backup withholding. Independent contractors often work in creative and technical fields, such as web development, content creation, graphic design or IT.

    An independent contractor may also be referred to as a 1099 employee, which refers to the tax form provided at the end of the year. Contractors who earn at least $600 from a client or company will receive a 1099-MISC form from that client or company, which outlines the total income received for the calendar year. Independent contractors who work with multiple clients would receive multiple 1099-MISC forms. All the income listed on each form would be included on the contractor’s tax return, and all required self-employment taxes must be paid from those forms.

    For the 2020 tax year, the IRS replaced the 1099-MISC form with the 1099-NEC form. This will be the form used going forward to report non-employee compensation. Companies and clients that use the services of independent contractors must send these forms by January 31 to provide adequate time for the contractor to prepare and file their taxes.

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    How To Pay Taxes

    Since taxes dont come out of the business owners pay like they would for an employee, the sole proprietor will pay an estimated amount quarterly. As a general rule, if a self-employed person expects to incur over $1,000 in taxes for the year, they will need to pay quarterly. While the business owner could wait to pay their taxes in the last quarter, there is the potential for an underpayment penalty from their state and IRS from underpaying the taxes.

    There are a few ways to avoid an estimated tax underpayment penalty by either

    Owing less than $1,000 in taxes for the current year or

    Pay estimated tax payments that total at least 90% of the total tax liability for the current year or 100% the total tax liability for the prior year, whichever amount is lower.

    As a new business filing for the first year, since there was no tax liability from the previous year, a sole proprietor may be able to wait until the end of the year to pay these taxes.

    Whichever route you go, its important to continually set aside a portion of the profits from the business to pay taxes, rather than try to scramble to come up with the funds as the penalties and fines can be substantial for underpayment.

    What Are The Qualifications For Small Business Health Insurance

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    In addition to being registered as a business based on your states regulations, you do need to have at least one employee in order to qualify for small business health insurance. You must also contribute to paying for employees monthly premiums as a business owner.

    As per the employer mandate in the Affordable Care Act :

    • It is optional for businesses with less than 50 full-time or full-time equivalent employees to offer group insurance plans, although they can decide to offer a group plan and may qualify for a tax credit to assist with cost sharing.
    • Businesses with over 50 full-time employees are required to provide group plans to their employees and pay at least 60 percent of premiums in their cost sharing solution.

    Whether or not you have employees as a sole proprietor, you can find both individual and group health insurance plans that fit your budget and preferences by visiting eHealth.com.

    This article is for general information and may not be updated after publication. Consult your own tax, accounting, or legal advisor instead of relying on this article as tax, accounting, or legal advice.

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    Can A Sole Proprietorship Be Defined As A Small Business

    Since the sole proprietorship and its owner are considered identical, a sole proprietor can generally be defined as a small business when it comes to qualifying for a small business health insurance plan however, if you have no employees but yourself, then your sole proprietorship will likely not qualify you for a group plan.

    Like other small business owners, sole proprietors do have the ability to hire employees. As per the IRS, any time a sole proprietor hires an employee other than an independent contractor, the sole proprietorship will need to obtain an Employer Identification Number . When working without employees, the sole proprietors Social Security number identifies the company for tax purposes.

    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 youre only responsible to yourself for the continued operation of the business.

    On the other hand, if you already have a very strong business plan, are hiring employees, or are concerned about liability, you might be better off starting your business as an LLC or corporation.

    Ultimately, a sole proprietorship is best for you when you have an idea and want to start immediately.

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    Can A Small Business Owner Be Both A Sole Proprietor And An Independent Contractor

    Its common for small business owners to operate as both sole proprietors and independent contractors, depending on the nature of the business relationship and the taxation structure.

    For example, a software developer who decides to start their own business quickly and easily might choose to operate as a sole proprietor, which does not require setting up a separate corporation and allows for the filing of personal and business tax liabilities on Form 1040.

    If the developer outsources their services to corporate clients, the customer might establish an independent contractor relationship, which means:

    • The employer is not responsible for withholding the developers payroll taxes.
    • The developer must pay for both their own share of payroll taxes and the employers share of Medicare and Social Security taxes.
    • The employer reports what it pays the developers business to the federal government via Form 1099-MISC.

    If the software developer decides to create and sell an iPhone app on the side, they are not an independent contractor for Apple but a merchant who receives a payment each time someone downloads the app. Because the developer is not an independent contractor, they don’t receive a Form 1099-MISC and instead reports the app-related revenue on Schedule C .

    At tax time, the developer pays income and payroll taxes based on having received both 1099 income from corporate clients and non-1099 business income from sales of the iPhone app.

    Does A Sole Proprietor Need Workers Compensation

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    A sole proprietor with no employees is typically exempt from being required to purchase workers compensation insurance for themselves. Some states have some extra stipulations where the owner has to purchase insurance, especially in high-risk industries, but most can opt-out.

    Workers compensation insurance may be worth considering as if the owner is injured at work and the income from the business is their only source of income, this insurance would replace the money they lost from the injury.

    Also note that even though an owner may not be required to purchase workers comp insurance, clients may require them to purchase this insurance before they can take the job. This is legal for the client to do and helps to protect their business.

    See more information about workers compensation

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    What Are The Insurance Implications Of Being A Sole Proprietor Vs An Independent Contractor

    Sole proprietors have less tax complexity than independent contractors but risk exposing their personal assets to business litigation, debt collection, or bankruptcy proceedings. Sole proprietors should be fully insured to protect against the major risks of doing business, such as:

    Lawsuits: Sole proprietors can be sued for several reasons, including unsatisfactory work, failure to meet deadlines, injury to a third party at a clients work site, and damaged customer property. To guard against such risks, sole proprietors should consider purchasing errors and omissions insurance and general liability insurance.

    Its also important to protect business assets with commercial property insurance, particularly for sole proprietors who rely on tools and other equipment to generate income.

    Injuries: Personal health insurance doesnt cover work-related injuries or illnesses, so sole proprietors should strongly consider buying workers compensation insurance for themselves, and some clients might require it. Having workers comp coverage reassures clients that they wont have to pay for your medical care if you get hurt while working for them.

    Sole proprietors who double as independent contractors also need business insurance, and if they are working as a service provider for a company, it could be a requirement. So if a contractor hurts someone or damages a third partys property, the contractors insurance policy pays for damages rather than the clients insurance.

    Typical Sole Prop Businesses

    There are certain types of businesses that usually run using the sole prop business structure.

    Typically, they donât require a substantial initial investment to get startedâfor instance, in the form of equipment or a brick-and-mortar location. That means they donât need the same loan liability protection, or the ability to bring on investors, as other types of businesses.

    • Landscaping businesses often start off as a single individual doing landscaping work, who may bring on employees or contractors to meet seasonal demand.

    • Home healthcare workers frequently operate as contractors, serving multiple clients in their homes. The sole prop is a good fit for this business model.

    • House cleaning businesses may start out as side hustles for their owners. Sole proprietorship is a good, simple structure for them.

    • Catering companies may get started informallyâfor instance, one talented cook feeding their friendâs wedding guestsâbefore taking off.

    • Freelancers, from developers to copywriters, typically operate as sole proprietorships. Since theyâre contractors who invoice clients, the organization of their business is fairly straightforward.

    • Consultants and speakers may operate as a sole prop as side businesses for someone who is otherwise employed full-time. One example is a full-time business executive who occasionally helps other companies improve their operations.

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    How Serious Are You About Your Business

    If youre taking your business venture seriously, as all entrepreneurs should, we dont think starting a sole proprietorship is a good idea. This entitys lack of personal asset protection is a non-starter, even if it seems like your business shouldnt have much liability. All it takes is one successful lawsuit against your business to wipe out your personal savings and put your other assets on the line. It simply isnt worth the risk, especially considering how few concrete advantages the sole proprietorship has over formal business entities.

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