Sole Proprietorship Advantages (Some Will Surprise You)
Are you considering sole proprietorship? Do you dream of self-employment? Check out this article to learn key sole proprietorship advantages. Also included are valuable tips about sole proprietorship.
Many people dream of self employment, of never having to go to an office again. No boss. No one to answer to. That is where sole proprietorship comes in. In this article we cover the advantages of sole proprietorship.
What is a Sole Proprietorship
According to the US Small Business Administration, a sole proprietorship is the simplest and most common business structure. It’s defined as a unincorporated business owned and run by one individual with no distinction between the business and the individual. Basically, a sole proprietor is a one person business that is not registered with the state as a business entity. This means that the sole proprietorship becomes the business type for income tax purposes.
Sole Proprietor vs Independent Contractor
The terms sole proprietor and independent contractor are often used interchangeably. This is because it’s not uncommon for someone to be both an independent contractor and a sole proprietor at the same time. Now you’re probably confused and wondering what are the differences between a sole proprietorship business and an independent contractor. Let us explain.
What is an independent contractor?
An independent contractor is an individual who works for someone else, not as an employee. They provide services, versus selling products. For example, a web expert, creative professional, technical person, etc. An independent contractor is any type of business entity, such as a corporation, LLC, partnership of sole proprietor.
Independent contractors receive 1099-MISC forms at the end of the year from the companies that they work for. Starting in the 2020 tax year Form 1099-NEC will be used. Employee’s receive a W-2 at the end of the year from their employers. Both of these forms show the total income received from their work. However, the difference is how their income is taxed. Payroll taxes are deducted from each paycheck when you’re an employee. This includes self employment taxes such as Social Security and Medicare. When you’re an independent contractor these taxes are not automatically deducted and are instead paid by the contractor.
Also, as an independent contractor you keep track of your own income and your expenses. Independent contractor income and expense information is entered into Form Schedule C, which is attached to an individuals Form 1040 at the end of the year. An easy way to track business expenses is with a mobile app like Falcon Expenses.
How can you be an independent contractor and a sole proprietor at the same time?
You are both and independent contractor and a sole proprietor if you work independently and provide professional services to other people and businesses. To work independently means you don’t work under a registered business entity such as an LLC, corporation or partnership. Independent contractors and sole proprietors are business owners or the type of business entity known as, sole proprietorship. They both file taxes using a Schedule C. In addition, they both pay self-employment taxes.
So what’s the difference between a sole proprietor vs an independent contractor?
The main difference is how income is received. A sole proprietor received income from selling product(s) and / or services. When a sole proprietor sells services they earn 1099 income, and receive a 1099-MISC (or in 2020 a 1099-NEC) from whomever they work. An independent contractor only earns 1099 income. 1099 income is income received for professional services, such as consulting, web development, etc.
Advantages of a Sole Proprietorship
Below we explain a few of the many benefits of a sole proprietorship.
- Easy to form. No corporate formations.
- Complete control. You only answer to yourself.
- Simple tax filing. Attached a Schedule C form to your 1040, that’s it.
- Owner gets all income. There’s only one owner, so all profits go to you.
- Privacy. Sole proprietorships are not subject to public disclosure.
Easy to Form
When we talk about formation, we are referring to incorporating, such are forming a corporation, LLC or partnership (unless you’re a single member LLC). All of these are complex processes that require time and money. In regards to a sole proprietorship you don’t have to form anything. All you have to do is start doing business.
Since you are the only owner of your sole proprietorship you have complete control of your business, and business activities. This means that you’re in control of your profits (and losses). More importantly, you don’t need to consult or get approval from partners, officers, shareholders or directors. Instead, you are the sole decision maker.
Simple Tax Filing
With a sole proprietorship you do not have to file separate taxes for your business. Instead, you simply attach an IRS Schedule C form (Profit and Loss from a Business) to your annual IRS Form 1040. Review the following article for detailed information on IRS Schedule C form, What is an IRS Schedule C Form (and What You Need to Know About It).
Owner Gets All Income
Since by definition a sole proprietorship has only one owner, this means all profits and income go to the owner. However, the same is true for losses. If you don’t make a profit then you don’t get anything.
Sole proprietorships are not subject to public disclosure like LLCs and corporations because they’re not required to file any formation documents or annual reports. LLS and corporations are required to file certain documents and annual reports with state and federal governments, some of this information is publicly available. This doesn’t apply to single member LLCs because they are sole proprietorships.
Disadvantages of a Sole Proprietorship
It wouldn’t be fair if we didn’t include a section about disadvantages of a sole proprietorship. This is because it is important to stay objective despite the fact that this article is about sole proprietorship advantages.
Liability of Debts
Your business debt becomes your personal debt when there’s no legal distinction between between personal and business assets. Legal distinction is established when you incorporate an LLC, corporation or partnership. But these business types comes with complex formations, extra costs, more complex taxes, annual reports and other headaches. Therefore, a sole proprietorship is the way to go if you’re interested in starting a simple business with no debts or lines of credit.
This is both an advantage and a disadvantage, depending on who you ask. At the end of the day you are fully responsible for all of the day-to-day business decisions.
Sole Proprietorship Taxes
Sole proprietors do their taxes by filing a Schedule C form with the IRS. You pay business income taxes on the income that your sole proprietorship business earned by filing an IRS Schedule C form.
How do I know to use a Schedule C and not another tax form for my business?
The IRS automatically considers your business a sole proprietorship if you haven’t registered as an other legal entity such as an LLC, corporation or partnership.
How do you become a sole proprietor?
You don’t need to register your business with your state to become a sole proprietor. All you have to do is start doing business and at the end of the year attach a Schedule C form to your 1040 form to report the profits and losses from your business.
Sole Proprietorship Examples
Maria is a web developer. She develops websites for more than one company at a time. Currently she is working on five web development projects. Because she is not an employee of any company and she works for herself she can work with more than one client at a time. She earns about $5000 to $10,000 per month as a web developer. Last year she earned $75,000 between ten different clients. Each client gave her a 1099. She included the income earnings data from each 1099 on her Schedule C form, which she attached to her 1040 when filling her personal income tax return. She also included her tax deductible expenses. Last year she bought a new computer for her work, so she was able to deduct that purchase accordingly from her taxable income.
John makes custom wood picture frames for people. It was a side gig that turned into full time self employment work a few years ago. He earns about $45,000 a year making custom frames for paintings and homes. John never incorporated, as he didn’t want to deal with the hassle of all of the paperwork, reporting and extra costs. Instead he is a sole proprietor who sells a product, wood frames. Therefore, at the end of the year he reports all of his businesses income on a Schedule C form. One this form he includes his gross sales, and all of his expenses. His expenses include the cost of goods sold, such as the wood and other supplies required to make the frames. He attaches his completed Schedule C form to his 1040 form and files his taxes.
About Falcon Expenses
Falcon Expenses is an iOS solution for expense tracking and management. Scan receipts, we type merchant, date and amount, auto-track mileage expenses via GPS and log billable hours with an integrated timer. Quickly organize expenses by time period, project or client and easily prepare reports for email to anyone in PDF or spreadsheet formats, all from your phone. Use for reimbursements, taxes, record keeping or invoicing. Falcon Expenses is great for professionals, freelancers, realtors, business travelers, truckers and more. Find out more, here.
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