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Whether you are self-employed or an entrepreneur launching your own business, managing your taxes is a cumbersome task.
Where taxes can induce headaches to many entrepreneurs, entering into a sole proprietorship will save you from future troubles and risks.
For budding entrepreneurs, sole proprietorship is the best option which forgoes all that drudgery and ensures you don’t get headaches.
But when is the right time to switch to sole proprietorship?
To find the answer, continue reading this post and learn the key differences between a sole proprietor and an individual.
Before we dig into differences, let’s understand who a sole proprietor is.
Who is a Sole Proprietor?
If you are coming across this term for the first time, then this accounting jargon might be terrifying for you.
In a nutshell, a sole proprietor is an individual running a business, without any registration with a state, as a separate business entity.
It is the simplest and most common way of beginning a venture and dealing with your taxes conveniently.
For becoming a sole proprietor, you don’t need a separate license or registration like you do when incorporating your business. In fact, you might be a sole proprietor already and are unaware of it.
The Internal Revenue Service (IRS) requires Non-incorporated business owners or self-employed people to report their profit and losses under the status of sole proprietorship.
Self-employed individuals, like being a freelancer or a contractor, are accountable for paying quarterly estimated taxes, income taxes, and filing self-employment tax returns.
You can enjoy an individual business owner’s perks until your business generates a net profit of $400 annually.
Once you cross the $400 per annum mark, you have to report your business’s income earned after subtracting your business expenses and cost of goods sold.
Key Differences of Sole Proprietor vs Individual
One-person operations are also commonly known as “solopreneurs” or personal businesses.
These solopreneurs enjoy long term benefits as compared to the owners of individual businesses.
Here are some advantages you can enjoy as a sole proprietor.
Being a sole proprietor, you have complete authority over your business. You control all the business decisions and changes.
So if you are someone tired of taking approvals from higher authorities, you can become your boss through sole proprietorship.
With a sole proprietorship, you won’t need other partners’ or shareholders’ consent. You will be your business’s sole decision-maker.
Super Inexpensive and Simple
If you are worried that you will have to pay hefty government fees, fill out lengthy forms as a sole proprietor. I suppose you might be mistaken.
By becoming a sole proprietor, you only have a different taxation system.
Apart from that, you won’t require any form or go through the hassle of obtaining a license etc.
However, you might need to pay for a separate business name and fill in a simple government form requiring a small amount of filing fees.
An LLC or a corporation requires public disclosure of formal documents such as Annual Reports, Income Statements, Semi-Annual reports, or any other significant change in the organization.
You can easily escape this hassle of going public with sole proprietorship.
Since you did not file for any documents with the federal or state Government, you can maintain your privacy and comfort.
As a sole proprietor, you become your business. Which means your earnings and assets are your business’s as well.
Under sole proprietorship, you and your business are not separate entities.
Your personal assets, such as a house or a car, can be seized for paying off a company’s debt.
You are legally liable for your business’s actions in a sole proprietorship, which is the most significant difference between sole proprietorship vs individual incorporated business.
Another critical factor to keep in mind between sole proprietorship vs individual’s incorporated business is that the state does not require business conversion for a sole proprietor.
An incorporated company must convert itself into a private or public limited company when it hits an average turnover of over Rs. 2 crores or a paid-up share capital of over Rs. 50 lacs.
A sole proprietorship, on the other hand, doesn’t need conversion regardless of the revenues it generates.
Nominal Reporting Required
Sole proprietors can safely get away without conducting annual meetings with shareholders or announcing quarter or annual reports for the public.
This advantage will reduce your work to half as compared to being an individual incorporated company owner.
A sole proprietorship does require minimal reporting for tax reporting, which is, unfortunately, the case with every other business entity.
Submission to Government’s Rules
When you are a sole proprietor, you do not have to worry about numerous Government’s rules and regulations regarding businesses.
Under the provisions of Section 44 AB of the Income Tax Act, the State will audit your accounts, if your business crosses the specified turnover threshold.
So sole proprietorship gives you a chance to focus more on your business operations and worry less about complying with Government’s laws.
The exclusive difference between being a sole proprietor vs individual business owner is the taxation process.
The sole proprietorship tax advantages are simplified reporting requirements and not paying separate taxes for the business.
You do not need to file any particular tax forms with the state or federal government for a sole proprietorship.
The only thing that distinguishes you as a sole proprietor is the federal Government’s requirement of attaching a Schedule C to your Form 1040 when filing taxes with the IRS.
The government and legal laws consider you and your business as a single entity; therefore, you report and pay your sole proprietorship taxes as a part of your tax return.
Let’s learn more about the taxation process of sole proprietorship so that you can make a more informed decision.
Sole Proprietorship Taxation Process
The taxation process of a sole proprietor is very straightforward as compared to other business entities. However, for your assistance, you should be mindful of a few things.
The IRS calls this taxation process a “Pass-through taxation”. It means that the net income earned by your business can push you into a higher tax bracket.
After that, you must fill in a Schedule C form, along with your personal income tax form, Form 1040.
As a sole proprietor, you can not show these tax payments as your net income statement’s expenses.
Your business’s profits are accountable to the tax deduction, even if you have left some amount for future spending, it is still tax-deductible.
Like any regular employee, every self-employer has to pay taxes, including Social Security and Medicare Systems.
However, the tax deduction takes place from regular employee’s paychecks; in the case of a sole proprietor, you will have to pay these taxes with your other income taxes.
Establishing your business as a sole proprietor has its own advantages. However, before making this decision, you must take all other factors into consideration
In case if you plan to get an investment in the future or your assets need protection, you should consider other options such as an LLC or a partnership.
But if you are a solopreneur and are looking for an easy way to handle your taxes, a sole proprietorship is a godsend.
I hope the eight critical differences between sole proprietor vs individual business will help you figure out your business’s future needs and achieve success in the longer run.