All things Sole Proprietor and Partnerships
Imagine: you have surpassed gifting your homemade jewelry to friends and family and have bravely decided to take your talents to Etsy. As an individual starting your own business, there are many considerations to take into account — the first being the opportunity to register your business under a specific entity, such as a Corporation or Limited Liability Company (LLC). Reasons you may consider one of these entity types depend on your preferences regarding taxation, legal protection and control of the business. (More on entity types here). If you opt out of incorporating or registering as an LLC, then your business is a Sole Proprietorship.
A “Sole Proprietorship” may sound complicated, but it’s nothing more than jargon for an individual who owns a business and is personally and solely liable for its debts. Running your jewelry business may require buying materials, maintaining and promoting your Etsy shop, and eventually hiring an employee or two to manage orders. As a Sole Proprietor, you are personally responsible for these costs, as well as any debts incurred while operating your business.
Other cornerstones of a Sole Proprietorship
- Sole Proprietorships are easy to set up and can cost significantly less to maintain than other entity types. Other than an EIN/Tax ID, Sole Proprietorships don’t require additional formation by the state or IRS.
- Sole Proprietors tend to run small or part-time businesses and typically have few or no employees.
- As a Sole Proprietor, you are 100 percent liable for any and all business debts. If the business goes south, you open yourself up to lawsuits that, if won, will jeopardize your personal assets. For example, if someone sues your business and wins, they can go after your home.
- A Sole Proprietorship is recognized as a legal entity and but is legally and financially indistinguishable from its owner. This means you must report the net profits or losses of your business on your personal income taxes (known as “pass-through taxation”). In addition, you are required to pay a self-employment tax of 15.3 percent to the federal government.
- However, Sole Proprietorships offer unmatched flexibility. You have unlimited control over your business, its proceeds and its resources.
It’s important to note that a Sole Proprietorship is owned by one person and one person only. Unlike other entity types, Sole Proprietorships cease to exist when the business owner dies, retires or decides to sell the business. If and when a Sole Proprietor offers partial ownership to another business or person, the company will no longer be treated as a Sole Proprietorship but as a Partnership.
General Partnership
If you share ownership of your business with at least one other person, you are considered a General Partnership. Similar to a Sole Proprietorship, a General Partnership also offers pass-through tax liability, low cost of formation and flexibility, but all members of a General Partnership remain personally liable for the debts and obligations of the business.
The 411 on EIN
Regardless of your entity type, you will need a unique number — known as an Employer Identification Number (EIN) or Tax ID — to identify your business to the government and the IRS. In some cases, you are able to use your Social Security Number (SSN) to identify your Sole Proprietorship; however, if you plan to hire employees, establish payroll, open a bank account in your company’s name or acquire credit, you will need an EIN/Tax ID. Even if you don’t need one today, there’s no harm in applying for an EIN and having it available should you need to do any of the aforementioned tasks. It also comes in handy when trying to conceal your personal SSN on invoices and other business forms.
Note: Individuals are only allowed one Sole Proprietor EIN/Tax ID in their lifetime. If you applied for/received a Tax ID but no longer need it or would like to get a different EIN for another purpose, you will need to cancel the original EIN with the IRS.
What’s in a name?
As a Sole Proprietor, the legal name of your business is your name — exactly the way you listed it on your Tax ID application. The legal name of a Partnership is the name provided by the owner(s) for state filings. You have the option of filing for a fictitious trade name or a DBA (“Doing Business As”), which allows you to choose a different business name you wish to be recognized by. It can even be required for business bank accounts opened for Partnerships if you want all partners to have access to the account. Whichever name you choose, you will need to file the appropriate forms with the county in which you are conducting business.
If you’re still unsure whether or not your business qualifies as a Sole Proprietorship, Partnership or something else, take our quick survey to determine your entity type.
About the author
From selling flowers door-to-door at hair salons when he was 16 to starting his own auto detailing business, Brett Shapiro has had an entrepreneurial spirit since he was young. After earning a Bachelor of Arts degree in Global and International Studies from the University of California, Santa Barbara, and years traveling the world planning and executing cause marketing events, Brett decided to test out his entrepreneurial chops with his own medical supply distribution company.
During the formation of this business, Brett made a handful of simple, avoidable mistakes due to lack of experience and guidance. It was then that Brett realized there was a real, consistent need for a company to support businesses as they start, build and grow. He set his sights on creating Easy Doc Filing — an honest, transparent and simple resource center that takes care of the mundane, yet critical, formation documentation. Brett continues to lead Easy Doc Filing in developing services and partnerships that support and encourage entrepreneurship across all industries.
Entity types: which option is best for my business?
The first decision most entrepreneurs face when starting a business is to choose its structure or entity. Entity choice is a critical decision, as it has far-reaching legal and tax consequences.
At some point, you will likely ask yourself: Should I form a C-Corporation? An S-Corporation? A Sole Proprietorship? An LLC? Should I even bother forming an entity? How will this affect my liability, control and taxes?
Below, the most common business entities are detailed, including advantages and limitations of each. Keep in mind that there is no one-size-fits-all entity type. The structure of your business should be determined by your product or service offerings, finances and number of business owners or partners.
Sole Proprietorship
If you own your business, have no partners, and have not filed any documents with the Secretary of State, your company is a Sole Proprietorship. The advantages of a Sole Proprietorship include flexibility, pass-through tax liability (also known as single taxation), simplicity, low cost of formation and elegance of management. However, a Sole Proprietorship leaves your personal assets unprotected. If someone sues your business and wins, they can go after your home, for example.
General Partnership
If your business is owned by more than one person, but you have not filed documents with the Secretary of State, your entity type is a General Partnership. All members of a General Partnership remain personally liable for the debts and obligations of the business. Similar to a Sole Proprietorship, a General Partnership also offers pass-through tax liability, low cost of formation and flexibility, but does not protect the personal assets of partners.
LLC
A Limited Liability Company, more commonly referred to as an LLC, is currently the most common entity choice for new businesses. The LLC offers protection of personal assets, pass-through tax liability and significant flexibility in the management, ownership and operation of the company. Individuals with an ownership interest in an LLC are called members, with one or more members being designated as the managing member(s). The biggest advantages of an LLC include flexibility to establish management, voting rights and dissolution rights in accordance with the members’ desires. An LLC also offers less annual maintenance and lower legal costs than, for example, a Corporation. This is because LLCs do not have the obligation to hold annual meetings, prepare minutes or report to a board or shareholders.
S-Corporation
The S-Corporation entity is frequently chosen for many of the same reasons that an LLC is. It offers protection of personal assets and is taxed on a pass-through basis; however, it has notable limits. With an S-Corporation, you are unable to have more than 100 shareholders — including any foreign or entity shareholders — or issue preferred stock. Forming a Corporation requires filing documents with the Secretary of State, as well as payment of a fee.
C-Corporation
A C-Corporation protects your personal assets but is taxed at both the entity level and the individual level (double taxation). C-Corporations are attractive to certain investors because they can be beneficial tax-wise depending on other holdings. With a C-Corporation, you can issue preferred stock and have as many shareholders as you want, including foreign or entity shareholders. You will pay a premium for these rights via higher taxes. All public corporations must be C-Corporations; however, if you don’t plan on going public within three to four years of opening your business, it is likely more cost effective to operate as an S-Corporation or LLC and convert to a C-Corporation prior to going public.
Summary
In addition to the above, there are also Professional Corporations, Limited Liability Partnerships and Limited Partnerships; however, these entities are typically only advisable in narrow circumstances which do not apply to the majority of new companies. Of the entities discussed in detail above, Corporations and LLCs are the only two entities with corporate shields. Their corporate shields are identical, in that they offer the same protection of your personal assets. Where they diverge is the following:
- LLCs offer more flexibility and lower maintenance costs than Corporations
- LLCs have few disadvantages aside from the possibility that your future investor/buyer might have a slight preference for Corporations and may require you to convert
However, investors are becoming increasingly comfortable investing in LLCs, and with all of its other advantages, the LLC is the ideal choice for most small businesses.
At the end of the day, you will want to choose the entity type that makes the most sense for your business. If you’re still unsure of which entity type to choose, you can take a quick survey here.
About the author
Heather Orr is an accomplished business law attorney who, after many years as a litigator, built a practice dedicated to keeping small businesses and startups out of the courtroom. She has served the entrepreneurial community through her firm, HSO Law, since 2009. Heather also served as an adjunct law professor at Loyola Law School for three years, where she taught a course on business planning, and is the author of How to Like Being a Lawyer.
