Should New Business Start As Sole Proprietorship?

Starting a new business can be exciting yet challenging, and one of the crucial decisions you'll face is choosing the right business structure. While a sole proprietorship might be a perfect fit for many, it could be less suitable for others. Here, we break down the pros and cons of starting as a sole proprietor and the factors to consider in your decision-making process.

What is a Sole Proprietorship?

A sole proprietorship is the simplest form of doing business. You can start by selling your product or service without needing a Tax ID (EIN), a Doing-Business-As (DBA) registration (though recommended for marketing), or a separate bank account (also recommended for bookkeeping). All your income and expenses are reported on your personal 1040 Tax Return under Schedule C.

Advantages of a Sole Proprietorship

• Simplicity: No formal setup is required. Just start your business.
• Immediate Start: You can begin operations right away, testing your product or service.
• No State or Federal Filings: A DBA may not be necessary.
• Minimal Administrative Costs: Low setup and maintenance costs.

Potential Issues with a Sole Proprietorship

1. Self-Employment Tax: One significant disadvantage is the 15.3% self-employment tax on your net income, which can surprise new business owners with a hefty tax bill. However, if your net income is low, this might not be a significant concern.

2. Liability Exposure: As a sole proprietor, you are personally liable for the business's debts and liabilities. If you face substantial liability risks from your products, services, or location, consider setting up an entity like an LLC, which offers liability protection without the complex tax reporting requirements of a corporation.

3. Partners or Investors: If you have partners or investors, forming an entity is almost necessary. Partnerships require a partnership tax return and expose you to personal liability for your partner's actions. Documenting your business relationship is also crucial to avoid disputes.

Factors to Consider

• Income Level: If you expect to make over $30,000 in net income, an S-Corporation might be more tax-efficient.
• Liability Risks: For significant liability exposure, a single-member LLC provides protection while keeping tax reporting simple.
• Business Location: Establish your entity in the state where you do business to benefit from the structure. Filing fees and taxes can vary significantly by state.
• Business Goals and Branding: If you plan a robust marketing strategy and need to protect your brand, starting with an LLC or corporation might be wise to avoid future rebranding costs.
• Administrative Costs: If the costs of setting up and maintaining an entity outweigh the benefits, a sole proprietorship may be the right choice initially.

Starting as a sole proprietor can be a great fit if there are no significant liability issues and the business concept is still being tested. However, as your business grows, you might need to consider more complex structures. Always consult with a tax advisor or attorney to tailor the best strategy for your unique situation.

Takeaway Action Items

1. Consider an S-Corporation: If you anticipate making more than $30,000 in net income before year-end.
2. Consider a Single-Member LLC: For liability protection while maintaining simple tax reporting.
3. Consider an LLC with Partners or Investors: To avoid personal liability and document business agreements properly.
4. Evaluate Your Branding Needs: If a professional image and brand protection are crucial, avoid a sole proprietorship to save future rebranding headaches.

Choosing the right business structure is essential for your success. While starting as a sole proprietor is straightforward and cost-effective, be prepared to evolve your business structure as your needs change and your business grows.