When you form a business, you must first decide the choice of legal entity. The one that works best for your organization depends on structure, liability, management, and tax considerations. Businesses are generally formed as sole proprietorship, partners, corporations, and limited liability companies (although there are other entities not so common).
A sole proprietorship is a business that is run by one person alone, without the need of a partner or by creating a corporation, or other legal entity. It is the easiest type of business to form or to dissolve because the laws, internal and external regulations and formalities are greatly reduced. It is a one-man operation.
As a sole proprietorship you are the one who manages the business activities and have broad discretion to make decisions about how to direct the operation and distribute profits. You are only responsible for yourself without major upfront costs. Under this structure, you can conduct all sorts of business transactions including the hiring of employees and engaging into contracts.
There are many benefits and downsides of operating under the structure of a proprietorship. Here are the most critical factors.
No formal or internal paperwork and document filing must be done to begin operations as a sole proprietorship other than personal name registered and securing local licenses and permits. A sole proprietorship is the simplest and least expensive business structure to establish. Costs are minimal and limited to obtaining the necessary authorization to operate. You need not observe formalities such as voting and meetings associated with other business structures.
Many small one-person operations conduct business under the shield of an LLC but often do so to make the business appears more formal, larger and structured. However, those that elect for such route, pay the process with needless paperwork and accounting complications. If your interest is to embark on a freelance or side job, then this might be an alternative to consider as structuring a business entity would be needlessly complicated. You may still turn the business into a more formal business structure later such as a LLC as you scale up.
You can conduct your sole proprietorship under an assume name other than your own. This is generally known as DBA (“doing business as”) and for legal purposes it is also called a Trade Name. Once you pick a name that has not been taken, you can register it accordingly with the government. In the case of Puerto Rico is the department of state. With your personal trade name you can present yourself to customers with a different name or image. For example, if you are Jane Smith, instead of operating your lawn care services under your name, your trade name DBA could be Lawn Proof Services. If the name is available, you can register it.
Besides being able to register under a DBA, you can register certain types of intellectual property (typically something that you used your mind to create) that you may be using for your business. It generally consists of recognizable names and signs (such as brands, logos) that distinguish the goods and services of one business from another. If your sole proprietorship has valuable intellectual property, then you would register it separately (from a trade name) either in state or federal law under your personal name. As a sole proprietor you can also protect valuable information that you consider are trade secrets and confidential information preparing restrictive contracts where you are a part of and for whom there is legal protection to enforce violations.
Because you are the sole owner of the business, you have complete control over all decisions of your sole proprietorship. You aren’t required to consult with anyone else when you need to make decisions or want to make changes. When you have partners, shareholders, or members, you may not only need prior approval for certain decisions but also, follow certain legal formalities.
While this may not be advisable, owners can freely mix business or personal assets when needed without disrupting any formal legal entity or having to provide explanation to anyone.
Sole proprietorship taxation is simple. Your business is not taxed separately, so it’s easy to fulfill the tax reporting requirements for a sole proprietorship. The income earned by a sole proprietorship is income earned by its owner. The business itself is not considered a separate entity from the individual. As the owner of you own business you pay taxes filling a single Income Tax Return. Income from the business is specified in a tax form schedule.
The flip-side of complete control is the burden and pressure it can impose. You alone are ultimately responsible for the successes and failures of your business.
Besides your personal tax, if you intend to hire employees, you need to obtain an EIN, a 9 digit number issued by the IRS for tax reporting purposes. Every business including sole proprietorships having employees are required by law to report wages to the IRS using their EIN Also, in Puerto Rico, you are required to collect any applicable sales and use tax (IVU). The amount collected must be sent to the Treasury Department monthly.
The owner signs contracts and enters arrangement in its own behalf. Because there is no legal separation between you and the business, you as a sole proprietorship can be held personally liable for the debts and obligations of the business. This risk extends to any liabilities incurred because of your employees’ actions. You still can be sued personally if you are a professional engaged in malpractice or operate through a separate legal entity; but under much limited circumstances. In sum, you as the owner of the business assume the risks of its commercial activity, with its present and future assets, for all obligations incurred.
Sole proprietors often face challenges when trying to raise money. You cannot sell stock in the business, which limits investor opportunity. Banks are also hesitant to lend to a sole proprietorship because of a perceived additional risk when it comes to repayment if the business fails.
Being a one-man shop. Sole proprietorships are difficult to sell if it relies on the owner itself to operate and rarely survive the death or incapacity of their owners and so do not retain value.
Here are some thoughts that will help you as a sole proprietor of a business minimize risks and operate more efficiently
Treat a business both as as separate entity and as a reflect of your personal integrity and professionalism. Every transaction or action you take do it to the best of your abilities. Consider that you can be held liable personally in any business transaction. The better you perform the less liable that you will be at risk.
Consider property and liability coverage, auto insurance, health coverage, and disability coverage and if you are a professional, there is insurance for such endeavors. This can get expensive, but it’s the best way to protect your personal assets from claims and lawsuits, should they arise.
While it may or may not be appropriate, consider ways to make your assets not so accessible to creditors, like a home. That is what people do when they structure a legal entity. Owners of the entity are shielded from claims beyond their investment in the entity. Personal assets are generally off limits. If your assets are at issue, figure out ways to disassociate from them in a way that is legal.
Properly hiring independent contractors will help you minimize risk from problems that may arise with suppliers, clients, and employees. For example, if you need help to conduct operations, an independent contractor might be a good idea as opposed to hiring a worker. Be advised that some independent contractors are considered employees if the nature of their work and supervision is more likely to be one of typical employees. Also, you can contract services so that the other property provides it and is the one legally responsible. Be aware that in certain cases, you could still be liable for what the contractor does and that is why the redaction of contracts cannot be taken lightly. When contracting, the persons that will do the job is often required to have insurance to cover risks related to the job and to include the party requesting the services as an additional insured. Other clauses that you could include is the commitment of the contractor to hold you harmless from any claims and to defend you if litigation arises out of the work done.
Open a separate, sole proprietor business bank account. This will help you keep track of expenses, pay suppliers with a business name and make your business appear more legitimate.
Like a separate bank account, having a business credit card helps maintain that boundary between personal and business transaction of your sole proprietorship.
Keep accurate records to separate those expenses that belong to you and those from your sole proprietorship business (licenses, supplies, advertising, training, internet, phones). This will help for tax deduction items and allow you to understand how profitable your business is.
If you work from home, make a clear separate space fully dedicated to your work area.
Again, it’s not a good idea to mix family matters with business. A separate dedicated phone helps you keep that distinction when communicating with suppliers and clients. A separate phone ensures full deduction as a business expense.
Consider a different legal structure such as a corporation or a limited liability if you have growth plans and are considering hiring employees. These types of entities will help you minimize operational, financial, and legal risks associated with running a business. However, if you are just starting and want to keep running a small business as proprietor, it makes sense to keep it that way and operate indefinitely just know the risks and take the necessary precautions.
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