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 dont 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.
What Is The Difference Between A Sole Proprietor And A Self
Sole proprietor and self-employed mean the same thing essentially. A sole proprietor is the only the sole person who runs his or her business. A sole proprietor is not the same as an independent contractor. An independent contractor typically works for another organization or multiple organizations, such as a creative professional a graphic artist or writer.
An independent contractor will not have taxes held from any payments. Sole proprietors are responsible for paying taxes associated with their businesses.
Forming A Sole Proprietorship In Other Countries
Sole proprietorships are not exclusive to the United States. These types of businesses bloom everywhere, as they benefit entrepreneurship and single-owned businesses greatly.
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Registering Your Sole Proprietorship
Unlike an LLC or a corporation, you generally don’t have to file any special forms or pay any fees to start working as a sole proprietor. All you have to do is state that your business is a sole proprietorship when you complete the general registration requirements that apply to all new businesses.
Most cities and many counties do require businesses — even tiny home-based sole proprietorships — to register with them and pay at least a minimum tax. In return, your business will receive a business license or tax registration certificate. You may also have to obtain an employer identification number from the IRS , a seller’s license from your state, and a zoning permit from your local planning board.
If you do business under a name different from your own , you usually must register that name — known as a fictitious, or assumed, business name — with your county. For more information on filing and publishing a fictitious business name statement, see Registering Your Business Name.
In practice, lots of businesses are small enough to get away with ignoring these requirements. But if you are caught, you may be subject to back taxes and other penalties.
For more help in deciding on the best legal structure for your business, see LLC or Corporation? How to Choose the Right Form for Your Business, by Anthony Mancuso .
|Take our business formation quiz for help deciding the best structure for your business.|
How Are Owner Draws Reported To Irs
At the end of the year or period, subtract your Owners Draw Account balance from your Owners Equity Account total. To record owners draws, you need to go to your Owners Equity Account on your balance sheet. Record your owners draw by debiting your Owners Draw Account and crediting your Cash Account.
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A Special Tax Deduction For Pass
Sole proprietors, along with other types of pass-through businesses, can get an additional tax deduction of 20% from their business income through a Qualified Business Income tax deduction. The deduction is in addition to ordinary business deductions. There are requirements and limitations on this deduction, so check with your tax professional for more details.
See IRS Publication 535 Business Expenses for details on how to deduct business expenses, including limitations and restrictions on these deductions.
What Is The Legal Definition Of A Sole Proprietorship
The U.S. Small Business Administration defines a sole proprietor as a single person. The business is not distinguished from the owner. The owner is entitled to all profits. He or she is also responsible for losses and liabilities.
Consider freelance writers. They advertise their own services. They complete client projects. They accept their own payments. They file their own taxes.
Many small businesses can work under this structure. They include:
- Academic tutors
- Freelance accountants, graphic designers, web developers, and writers
- Single-person art studios.
Sole proprietors usually work alone. Yet, they can hire employees. In these cases, the business owner handles employee administration. He or she must manage their payrolls and file their taxes.
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Does A Sole Proprietorship Need An Ein
Among the many advantages of a sole proprietorship is its simplicity. It is easy to set up. And there is less paperwork, especially when it comes to taxes.
As a sole proprietor, you file your business income and expenses on your individual tax return. Additionally, you use your Social Security number for your business activities.
But if you hire employees or open a business bank account, you may need an EIN.
Open A Business Bank Account
Its important to keep personal and business expenses separate when running a sole proprietorship . Opening a business bank account ensures a certain level of protection for your business funds, allows customers to pay with a credit card and make checks payable to your business, and allows your business to build a good credit history.
You want to be able to prove to the IRS youre running your business to make a profit. This ensures the losses you experience during the first few years will remain tax deductible.
Its also wise to build a good credit history before starting your business. While credit cards can help you out in your companys early days when cash flow is low, the interest adds up quickly and can easily become overwhelming.
A personal loan is often a better option, and a good credit history is necessary for securing a loan of this type.
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What’s A Sole Proprietor
A sole proprietor has complete control over the revenue and operations of their business. However, the sole proprietor is also personally responsible for all debts, lawsuits, and taxes their company accrues. So, if their business is sued, personal assets like their home, credit score, and savings are unprotected.
Name Your Sole Proprietorship
With a sole proprietorship, you can name your business using your name, and you can also include a description of the work you do. For example, if your name is Joe Smith and you will open a landscaping business, you can name the company Joe Smith Landscaping without registering your business name. If you would prefer to call your business Trees and Shrubs, you would need to apply for a DBA name.
To apply for your DBA, start by researching name restrictions and availability. Restrictions in most states include avoiding false associations with other businesses or institutions, not using words that describe activities illegal in that state, and avoiding words associated with regulated industries like banking.
To determine name availability, you need to conduct a search of business names. Searches can be conducted through your states Secretary of State website. Most include a searchable database. Try searching for as little of your chosen name as possible, as this will give you more results.
Once youve selected a name, you can register your DBA name. Usually, this can be done online through your local county. Fees will vary between states. Before you take this step, though, its good to determine your businesss domain name. Most companies have at least some online presence, and you dont want to register a name and then discover it isnt available as a website.
If you decide to pursue a trademark, you will need to:
- Complete and submit your online application.
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Personal Liability For Business Debts
A sole proprietor can be held personally liable for any business-related obligation. This means that if your business doesn’t pay a supplier, defaults on a debt, or loses a lawsuit, the creditor can legally come after your house or other possessions.
Example 1: Lester is the owner of a small manufacturing business. When business prospects look good, he orders $50,000 worth of supplies and uses them in creating merchandise. Unfortunately, there’s a sudden drop in demand for his products, and Lester can’t sell the items he has produced. When the company that sold Lester the supplies demands payment, he can’t pay the bill. As sole proprietor, Lester is personally liable for this business obligation. This means that the creditor can sue him and go after not only Lester’s business assets, but his personal property as well. This can include his house, his car, and his personal bank account.
Example 2: Shirley is the owner of a flower shop. One day Roger, one of Shirley’s employees, is delivering flowers using a truck owned by the business. Roger strikes and seriously injures a pedestrian. The injured pedestrian sues Roger, claiming that he drove carelessly and caused the accident. The lawsuit names Shirley as a co-defendant. After a trial, the jury returns a large verdict against Shirley as owner of the business. Shirley is personally liable to the injured pedestrian. This means the pedestrian can go after all of Shirley’s assets, business and personal.
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Overview: What Is Sole Proprietorship Taxation
A sole proprietor is an entrepreneur who owns a business personally and has not incorporated the business. Typically, startups and side businesses are sole proprietorships.
Once your business reaches a certain size, it should be converted to an S corporation or C corporation. These business entity types allow for shares to be sold to outside owners and can reduce business taxes as the corporate tax rate is likely lower than what your personal marginal rate would be at that point.
A sole proprietor does not file a business tax return instead taxes are reported on the personal income return of the owner.
How Do You Tax An Owners Draw
An owners draw can also be a non-cash asset, such as a car or computer. You dont withhold payroll taxes from an owners draw because its not immediately taxable. Instead, you pay income tax and self-employment tax on your portion of business earnings, regardless of the amount you draw from the business.
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What Makes Sole Proprietors Different
Sole proprietors are one-person owners of unregistered businesses. That means they don’t register their businesses with a state. For legal and tax purposes, sole proprietorships are the only business type that isn’t separate from the owner. The owner is liable for all the debts of the business and can be sued in connection with its actions .
For tax purposes, a sole proprietorship is considered a “pass-through” business. The profits or losses of the business pass through to the owner’s personal tax return.
You’re a single-member LLC, and you pay income taxes in the same way as a sole proprietor, including self-employment taxes. If you’re the only owner of a limited liability company . This information applies to you, too.
S To Starting A Sole Proprietorship
A sole proprietorship is very simple to get up and running. Because you don’t have to register your business with the state, there aren’t many formal steps. However, there are certain things you may want to apply for, depending on certain changes you might like to make to your business. Here are some steps you may want to take:
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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.
Sole Proprietorships And Partnerships
A sole proprietorship is a business with only one owner.
A sole proprietor is self-employed, performs all business operations and assumes all liabilities.
A partnership company is operated by two or more parties.
In a general partnership, partners are responsible for all aspects of the business, including the debts of the partnership.
A limited partnership can have general and limited partners. Generally speaking, there’s a limit on the liability of a limited partner, while the general partner’s liabilities are not limited.
A limited liability partnership is has no general partners and all partners have limited liability.
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Does A Sole Proprietor Need Workers Compensation
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.
The Sole Proprietorship Is The Simplest Legal Structure For Owning Your Own Business
Sole proprietorships are so easy to set up and maintain that you may already own one without knowing it. For instance, if you are a freelance photographer or writer, a craftsperson who takes jobs on a contract basis, a salesperson who receives only commissions, or an independent contractor who isn’t on an employer’s regular payroll, you are automatically a sole proprietor.
However, even though a sole proprietorship is the simplest of business structures, you shouldn’t fall asleep at the wheel. You may have to comply with local registration, business license, or permit laws to make your business legitimate. And you should look sharp when it comes to tending your business, because you are personally responsible for paying both income taxes and business debts.
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How Does Sole Proprietorship Work
A sole proprietorship is not a legal entity on its own it is conjoined to the owner. This means that there is no legal separation between a sole proprietor and this form of business therefore, all the business losses are the owners personal losses. Likewise, the owner is personally liable for all the business debts the sole proprietorship obtains.
From the taxation point of view, this means that a sole proprietor can use their Social Security Number as an EIN .
There is no need to pick a business name the owner can run the business under their own name. The owner can also choose a fictitious name , but it has to be unique and registered with the local state or county agency.
In case you want to see an example of how sole proprietorship is set up, see our article on registering the sole proprietorship in Oregon, USA.