A sole proprietor is an unincorporated business owned and run by one individual. As a sole proprietor, you’re entitled to all the profits, but also personally liable for all losses and debts. Your business and personal income aren’t separate. This pass-through entity reports business income and expenses on the owner’s personal tax return using IRS Schedule C.
Upon starting a sole proprietorship, obtain an Employer Identification Number (EIN) from the IRS to hire employees. Otherwise, your Social Security number serves as the business identifier. With employees, you must pay payroll taxes, provide workers’ compensation and unemployment insurance. Sole proprietors can employ family, but must pay fair wages and meet legal requirements. They can be sued if employees act within employment scope.
Employee Numbers and Responsibilities
- Local regulations may limit employees at home-based sole proprietorships until you relocate to a commercial area.
- Consider payroll taxes, reporting and compliance when hiring.
- The number of employees is unlimited, and you can bring on direct hires or independent contractors.
- Expenses like healthcare costs are deductible.
As a sole proprietor, you can pay yourself through an owner’s draw. However, as you are not an employee, your income remains subject to self-employment tax. Sole proprietors have a more challenging time taking breaks, as the business cannot operate without them, making it difficult to take vacations or even weekends off.
Business Continuity
Upon the death of a sole proprietor, the business ceases operations. However, you can transfer the business by selling its assets since no separate business registration is required.
Starting Out and Growth
Many home-based enterprises are sole proprietorships. As businesses grow, many transform into a limited liability company (LLC) or a corporation.
Hiring Process
- Before hiring employees, obtain an EIN from the IRS.
- Employees must fill out all necessary employment forms, including W-4 and I-9.
Employer Responsibilities
Sole proprietors must follow:
- Employment administration
- Recordkeeping
- Taxes compliance
Tax Considerations
A sole proprietorship’s business income, expenses, profits, and losses flow through to the individual owner’s tax returns using IRS Schedule C Form 1040.
For tax purposes:
- You pay self-employment taxes towards Social Security and Medicare based on net self-employment income.
- New employees should complete a W-4 form for IRS tax withholding.
Changing Business Structure
Switching from a sole proprietorship to an LLC may provide personal asset protection. An accountant or lawyer can advise if a change in business structure is warranted.
Legal and Financial Aspects
To hire employees as a sole proprietor:
- Obtain an EIN.
- Have new employees complete W-4 forms.
- Set pay periods to coordinate IRS tax withholding.
- Comply with all state and federal employment laws.