Sole proprietorship is a business structure that is just the owner of the business; hence “sole.” You can have employees working for you, but only you can own the business.
Setting up this type of business structure is the simplest form, but it does have some requirements. There is less paperwork, and it is easier to maintain than partnerships or corporations. Being a solopreneur means you are responsible for the debts and liabilities, and the accounting and record-keeping methods are usually simple and straightforward. Other tasks that must be completed to be a sole proprietor is selecting a business name, filing for an EIN number (Federal Employer Number) and a Fictitious Business Name Statement (if you are going to use any name other than your legal name), and obtaining a business permit or zoning permit. Once those items are complete congratulations you are business.
The IRS sees you and your business as one entity and as such, will treat you that way. You will report profit and losses in your business on your personal 1040 tax form with a Schedule C attached.
As a sole proprietor, you must pay your self-employment taxes that includes payments to Social Security, Medicare, and your estimated taxes throughout the year. The IRS is a pay as you go system that means you must pay the majority of your taxes throughout the year when you receive the income and not at the end of the year. The IRS is watching solopreneurs to ensure they are getting their money. You will incur penalty fees from several hundred dollars up to thousands of dollars.
The IRS requires that you pay 90% of your tax fees during the year and not wait until the end of the year or you will have a penalty to pay. One way of eliminating this risk is to pay your estimated tax payments quarterly. Estimated tax payments are due as follows:
- Quarter #1: January 1 to March 31 – due April 15
- Quarter #2 April 1 to May 31 – due June 15
- Quarter # 3 June 1 to August 31 – due September 15
- Quarter #4 September 1 to December 31 – due January 15 of the following year
Other ways to reduce your tax penalties is to increase your tax withholdings if you have other income from a second job, retirement, and other investments. To increase your tax withholdings you will need to update your W-4 and provide it to your employer or investment company. Speak to your tax accountant or CPA for the quarterly amounts you will owe. However, if your first starting out you may want to use the tax withholding calculator the IRS has created as you don’t have a prior tax years’ forms to figure the amount.
I would calendar the estimated due dates of for your taxes payments, so you do not overlook them and you payment on time.
The IRS determines each year the percentages of self-employment taxes. For 2019 the self-employment tax is 15.3% on the first $132,900 of net income plus 2.9% on the net income above $132,900. I suspect most new businesses will not be exceeding income of $132,900 in the first year, however it always better to be prepared. Self-employment tax breaks down into 6.2% for federal taxes, 6.2% for Social Security and 2.9% for Medicare (total 15.3%).
Let’s recap if you are a sole proprietor the advantages to creating this business structure include: Easy to set up a business, owner enjoys 100% control of the business decision making, profits, and ownership of the business. Tax filing is simple as the income passes through to your personal income taxes, thus being tax only once. Another advantage is you can easily dissolve this business if need be.
The disadvantages are that you are 100% responsible for the liabilities that your business incurs. That means if a lawsuit is filed on your business your personal accounts, assets or property can be encumbered to cover the debt. Another disadvantage is if you want to add another owner to the business you will have to dissolve this business and begin anew
I hope that helps you to decide if you want a sole proprietorship as your business structure.
Check out also my video on Sole proprietorship.
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