Table of Contents
- Sole Proprietorships, Uncle Sam, and His Taxes
- Sole Proprietorships and Liabilities
- Sole Proprietorship Advantages
- Sole Proprietorship Disadvantages
- Final Words
Types of Business Structures: Sole Proprietorship is an introduction to the simplest of the structure types. In this series, I will try to help you in deciding on the type of business structure you want. The easiest and simplest of the business structures is to form is a sole proprietorship, but it does have its drawbacks.
There are four basic types of business structures: 1. sole proprietorships, 2.partnerships, 3. limited liability companies, and 4. corporations.
A sole proprietorship is actually the default type of business you create with just one sole owner, even if you do not do anything formally to set it up, in the eyes of Uncle Sam when he wants his portion of profits, and Lady Justice if you get sued.
As the sole owner, you can either use your name as the name of the business or you may want a “Doing Business As” (DBA). Let say your name is Bob Smith and you want to open a lawn mowing business. You can get the jobs lined up and when they pay you just tell them to make the check out to Bob Smith…
Or you could set up a DBA with the Secretary of State in your given state and reserve a name (after checking it is not already reserved) and call yourself something like “BS Mowers”.
It is always a good move to get a DBA if you think that you may want to move to another structure as you start to grow the business so you know that name will be available for an LLC or Corporation name one day.
Also remember that you will have to obtain any licenses that are required in your city, county, or state if you do choose certain businesses.
Sole Proprietorships, Uncle Sam, and His Taxes
Since sole proprietorships are not separate entities, taxes owed by the business are the responsibility of the sole owner.
Income Tax
All profits and losses from the business “pass-through” to the owner of the business and are reported on their personal income tax returns. You do this by filing the usual Form 1040 or Form 1040-EZ Individual Tax Form AND an attached Schedule C Profit/Loss from Business or Schedule C-EZ Net Profit from Business. Unless April 15 falls on the weekend, that is the last day you can have postmarked or risk IRS penalties.
Self-Employment Tax
As if Uncle Sam wasn’t already dipping in your funds, he wants you to pay for being self-employed (since no boss to do it for you) to take care of social security and Medicare taxes.
Self-employment taxes (at the time of writing this) are 15.3% of net earnings. That is divided as 12.4% for Social Security tax and 2.9% for Medicare tax. And again, this is over and above income tax…not a replacement for it.
You only pay Social Security on the first $137,700 (at time of writing) you make currently, so that’s good news if you are killing it cutting that grass. (On I side note if you are making that amount 1. Move to a better business structure to save on this and 2. If you are looking for somewhere to spend it, I am always available for donations. 😁)
As the sole owner, you need to add to your 1040 and Schedule C, a Schedule SE where you calculate your self-employment tax amount.
Quarterly Estimated Taxes
Also, don’t forget that April 15th is your known end results filing for the last year. Uncle Sam expects you to predict your year ahead of time and send him “quarterly” estimated taxes on April 15th (same day but for next year’s taxes), June 15th, September 15th, and January 15th.
Hopefully, your crystal ball skills are amazing and you know how many yards you are going to cut so you can properly pay your taxes each quarter. Try to do the best you can because even though Uncle Sam will refund you when you overpay during the year, it’s, in reality, an interest-free loan you just made him. Or you could just leave that overage with him and count it towards your next year’s quarterly taxes.
My unsolicited advice is as quickly as you can after the January payment, get with your accountant (even if you see them in the mirror every day) and get your 1040 and Schedules prepared and sent in so you can get the refund back asap OR see you won’t have the deduction and exemptions high enough and need to pay more with the return. Waiting until April means having to finish last year and pay next year’s first quarter in the same month. *OUCH!
You can help calculate your estimated taxes by using page 6 on Form 1040-ES, Estimated Tax for Individuals.
Sole Proprietorships and Liabilities
Legal Liability
As the business and the sole owner are one and the same, so goes the legal liabilities that the owner bears.
The owner of the sole proprietorships will be legally liable for all torts (civil wrongs) committed by or in the course and scope of the business. Let’s say that Bob Smith’s mowing service is cutting a yard and runs over something throwing it through a window. As the sole owner, Bob Smith would be personally responsible for the costs associated with the accident.
If there is not enough money in the company to pay, Bob will have to come up with the rest, plus will have a personal judgment against him that would follow him whether the business still exists or not.
Financial Liability
Just like with legal liability, Bob will bear liability to all financial debts of the business. Bob gets gas for the mowers and the bill comes due, he is liable for anything business can’t pay. Bob needs to borrow money from the bank to increase the fleet of mowers, Bob is signing a personal note and deed of trust with the bank and will have to pay if the business can’t afford to pay. That also means that all of Bob’s assets (house, car, accounts, etc) are fair game for a creditor to come after even if the business goes under and closes.
So, you may be asking “Todd, What are the Sole Proprietorship Advantages?”
- Easiest and cheapest structure to start
- You only pay unemployment tax on your employees, not yourself (most are only themselves doing all the work or independent contractors)
- There are few, if any, ongoing formalities (board, meetings, Letter of Organization)
- No problem mixing business and personal assets, if needed.
- Complete control over the business and you make all the decisions unilaterally and exclusively. YOU ARE THE BOSS!
- You get all the profits! (You know less Uncle Sam’s cut)
So now you are asking “Todd, what are the Sole Proprietorship Disadvantages?”
- You are completely personally responsible for any debt, losses, and liabilities of the business. IE if your company incurs debt it’s on you and if you can’t pay, they can come after your personal assets that have nothing to do with the business.
- The business is only around as long as the owner. If you retire or die, it retires or dies. Most states make a business end and another file to start when ownership changes hands, unlike some other structures.
- You are personally responsible for the funding of the business and it is often difficult to raise starting capital and often personal assets have to be leverage for loans, which puts them at risk.
Final Words on Guide to Types of Business Structures: Sole Proprietorships
So, what is my final word on Types of Business Structures: Sole Proprietorships? The type of business structure you want depends on what your needs are.
If you are in a low-risk job, where you don’t have to have a lot of upfront cost or a low chance of business being sued or you don’t have a lot of personal assets yet to be risked, this is a cost-effective great starter structure.
You are not locked into a structure so you can move into a more protected structure as you begin to grow the business, increase your chances of being sued, or start to personally have assets that need protecting.
To see the next on the “Easy Guide to 4 Types of Business Structures” click the button below.
Here are some suggested books on business to help you along.