Basic Entity Choices in California--Part 1: Sole Proprietorships
This guide will focus on one of the five entity choices I will cover across five different articles. This guide provides a brief overview of sole proprietorships in California.
Oragnization and StructureA sole proprietorship essentially comes into existence when a single individual begins running his or her own business. Yes, you should get a business license, a federal employer ID number, insurance coverage, and file a fictitious name statement, but "hanging a shingle" is about all there is. A sole proprietor can hire employees or independent contractors, but the sole proprietor is the only owner. If a sole proprietor takes on another owner--or vests someone else with enough responsibility to make them a de facto owner--the law will very likely treat that business entity as a partnership. The benefits of a sole proprietorship are that it is often the simplest, quickest, and cheapest business entity to form and manage. As a sole proprietor, sole management authority rests in you as the business owner. Depending on your personality and risk tolerance, this characteristic can either be a benefit or a drawback. With sole ownership and management responsibility comes personal liability. This is the most important point about sole proprietorships: a sole proprietor is personally liable for all of the debts and obligations of the business. In other words, if you were subject to a judgment from a lawsuit that exceeded the amount of capital you had contributed to your business plus any accumulated revenue, the defendants could go after your personal assets to satisfy the judgment.
TaxationFederal and state income tax authorities consider a sole proprietorship to be a "disregarded entity," and treat all income and expenses of the business to be the owner's personal income and expenses. A sole proprietor must also pay the federal "self employment tax," which is currently assessed around fifteen percent (15%) of all net earnings. This can end up being quite a lot, and a common strategy to minimize this burden is to form an S corporation and pay yourself a reasonable, yet small salary. That gets into some higher level stuff, but keep that idea in your arsenal when you go to meet with your attorney. A sole proprietor who hires employees will have to pay all relevant taxes and withholdings associated with employment. A sole proprietor will also have to pay other miscellaneous state taxes, such as sales tax and the like. A sole proprietorship is no different than any other business entity in this regard.
FormationThere are generally no state or federal registration requirements for forming a sole proprietorship. The most important, and sometimes only, step in forming a sole proprietorship is obtaining a business license from your municipal or local governmental authority. Prior to engaging in any business, however, be sure that you obtain any and all necessary licenses, permits, or exemptions. For instance, you may need a use permit or exemption if you plan on running your business out of your home as there are often zoning restrictions in residential neighborhoods that limit or prohibit business operations. If you intend on using a business name that is different from your personal name, then you will likely have to file a "fictitious business name statement" or a "doing business as" with your municipal or local governmental authority, and then publish your "d.b.a." in the local newspaper for a required period of time. If you do not hire employees, then your Social Security Number will double as the business's tax identification number. If, however, do you hire any employees, you will need to obtain a federal employer identification number ("FEIN") by filling out and filing IRS Form SS-4, or just doing it online. I'd include a link, but Googling it takes about .004 seconds.