So you’ve decided to start a business in California. And you’re all for keeping it simple. But what does it really mean to have a sole proprietorship? California LLCs and corporations come with a myriad of responsibilities. But when it comes to being a California sole proprietor, running your business is as easy as it gets.
Does easy actually mean a California sole proprietorship is the best choice for your budding business? Should you operate as a sole proprietorship in California, rather than as an LLC or corporation?
We break it all down for you below to help you determine what entity is best for your business.
What’s a Sole Proprietorship?
A sole proprietorship is a business where the owner (referred to as the sole proprietor) personally owns the company, including all of the assets.
In other words, there’s no separate legal entity like there would be with an LLC or a corporation. Just like owning your car or your house, you’ll own the business.
What if you co-own your business with one or more individuals?
Well, then you can’t be a sole proprietor. As the name implies, sole proprietorships are one-owner businesses.
If you want co-owners and partners, you can opt to form a multi-member LLC, a partnership, or a corporation.
Sole proprietors are commonly called “self-employed.”
When you operate as a sole proprietor, you aren’t actually an employee of your business. Rather, you’re the owner.
On top of that, you aren’t an employee of your customers or your clients. Instead, you’re classified as an independent contractor, which is an individual that performs services for clients and customers without being considered an employee.
All sole proprietors are independent contractors.
Perks of Being a California Sole Proprietor
There are a few reasons why operating your business as a sole proprietorship in California is a great idea.
Affordable and easy to run
You don’t have to form a separate legal entity like you would with an LLC or a corporation. And, you don’t need to file articles of organization with the California Secretary of State.
You don’t even need to draft an LLC operating agreement. You simply start doing business and- boom– you’re a sole proprietorship in California.
But do sole proprietors need a business license in California?
The answer is yes. Even as a California sole proprietor, you’ll likely need a business license from your city or county. But that’s about all of the paperwork that you’ll need to get your business up and running.
There’s a lot that you don’t need to worry about as a sole proprietor. California sole proprietor’s don’t need to:
- Hold LLC or corporate meetings
- Periodically file paperwork with the Secretary of State.
- Pay any special state taxes or fees
You own the business personally
This means that you make all of the decisions and don’t need to consult with anyone. You’re the supreme ruler of your business. *muwhahahahaha*
Everything that your business owns, you personally own. In other words, all of the money that your business earns is your personal money. Even though it’s wise to have a separate bank account for your business, it’s not legally required.
Drawbacks of Being a Sole Proprietorship in California
When it comes to being a California sole proprietor, the biggest drawback is liability.
This can be scary because a business creditor (a person or company to whom you owe money for items you use in business) can go after all of your assets, including your personal assets. This could include your personal bank accounts, car, and house.
Similarly, a personal creditor (a person or company to whom you owe money for personal items) can go after your business assets, such as your business bank accounts and your business equipment.
As a sole proprietor, you’re personally liable for business-related lawsuits.
For example, if someone slips and falls in your (or your client’s) office, you can be personally sued for damages. This is why it’s wise to get insurance that protects you against these types of lawsuits.
Pro tip: You can avoid this level of liability by forming an LLC or a corporation, which will limit your personal liability for business debts and lawsuits.
California Sole Proprietor Taxes
How sole proprietors are taxed
Taxes are simple when you’re a sole proprietor in California because you and your business are one and the same for tax purposes. You don’t need to pay taxes or file tax returns separately for your California sole proprietorship. California taxes you, the owner, on the income you earn from your business, instead.
Instead, you report the income that you earn, or the losses that you incur, on your personal tax return (IRS Form 1040).
If your business earns a profit, you’ll add that money to any other income that you have. Other income can be interest income or your spouse’s income if you’re married and file jointly. You’ll get your total income that will be taxed at your personal tax rate.
If you incur a loss, you can use it to offset income from other sources.
To show whether you have a profit or loss from your sole proprietorship, file IRS Schedule C, Profit or Loss from Business, with your tax return. On the form, list all of your business income and your deductible expenses.
Just remember that, if you have more than one sole proprietor business, you must file a separate Schedule C for each.
Tax Deductions for California Sole Proprietors
As a sole proprietor in California, you’re entitled to the same tax deductions as any other business. Those deductions include mileage, office expenses, software, travel, and business equipment.
Plus, you’re also eligible to claim the pass-through deduction that took effect in 2018. This means you might be able to deduct as much as 20% of your net profits from your income taxes.
Sole proprietors aren’t employees
A sole proprietorship doesn’t pay payroll taxes on a sole proprietor’s income or withhold income tax. Because you’re working as an independent contractor, your clients don’t withhold taxes from your compensation.
Instead, as a sole proprietor, you pay self-employment taxes. Self-employment tax goes towards your Social Security and Medicare and is 15.3% of your net self-employment income. You’ll also pay income taxes on your earnings. These taxes must be paid four times a year in the form of estimated taxes.
Anyone that pays you $600 or more within a year must file Form 1099-MISC to report the payment to the IRS.
What Types of Businesses Work Well as Sole Proprietorships?
The great news is that a sole proprietorship works well for any one-owner business that doesn’t have employees, including part-time and side businesses.
But, if you have employees or partners, it might be a good idea to form a separate business entity, like an LLC or a corporation. This strategy will limit your personal liability for your employees’ actions.
You can always start your business as a sole proprietorship and convert to another form, such as LLC or corporation, later on if you end up hiring employees.
Note: if you really want to avoid any personal liability for business debts and lawsuits, forming an LLC or corporation is the way to go. Just keep in mind that even LLCs and corporations aren’t foolproof when it comes to personal liability.
Starting a Sole Proprietorship in California
At this point, you’re probably wondering how to start a sole proprietorship in California. We’ve got good news for you, friend. Because sole proprietorship is the default business form for a one-owner business, when you start a business in California you automatically become a sole proprietor.
You’re probably thinking, “Okay, this sounds too good to be true. How much does it cost to register a sole proprietorship in California?”
Besides the cost of getting a business license (which varies by city or county) you don’t have to pay any fees to register a sole proprietorship. California only requires that you pay registration fees if you form an LLC or corporation.
There are a few details, though, that you need to take care of when setting up a sole proprietorship in California:
Federal Tax ID (EIN)
As long as you don’t have any employees, you can use your Social Security number as your IRS and state tax ID number. But you might prefer getting an Employer Identification Number (EIN) from the IRS to keep your Social Security number private and safe from identity thieves.
Don’t worry, getting an EIN isn’t as scary as it sounds. Read our Freelancer’s Guide to Federal Tax ID (EIN) for more information on how to get an EIN.
There aren’t any IRS or legal requirements stating that you have to set up a separate bank account or credit card for your California sole proprietorship.
But, it’s a really good idea to have a separate business bank account. Your business account will help you accurately keep track of deductible expenses and is really useful if you’re ever audited.
It’s likely that you’ll need to get a business license from the city or county where your office is located. This involves filling out a simple application and paying a license fee. Just keep in mind that the process for getting a business license varies from city or county.
Because you’re personally liable for all business-related lawsuits as a sole proprietor, you can obtain business liability insurance to help protect yourself. The type of insurance and the level of coverage that you’ll need will depend on the work that you do.
Consult with an insurance broker if you aren’t sure of what direction to take in this area.
You can use your personal name to identify your sole proprietorship, and if that’s what you decide to do, you won’t need to do any government filings or pay extra fees to use your name.
But, you might prefer to use a different name for your business, which is called an assumed business name or DBA (“doing business as”). To use a name other than your own, file a fictitious name statement or assumed name certificate with the county where your principal place of business is located.
Just keep in mind that you can’t use a name that’s similar to a fictitious name already on file in your county, so be sure to search county records first.
Note: If you want to use an assumed business name, your sole proprietorship bank account should be created in that name. The bank will ask to see a copy of the fictitious name statement before it’ll open an account in your assumed name. Be sure to file your fictitious name statement before opening your bank account.
Think a Sole Proprietorship in California Is the Right Way to Go?
If you’re ready to become a sole proprietor, awesome! All you have to do now is start earning self-employment income and you’re officially a California sole proprietorship.
Still wondering if an LLC is a better fit for your business? See how an LLC compares to a sole proprietorship in California.
Whether you decide to form a sole proprietorship in California or an LLC, we’ll be here, cheering you on from the sidelines.
Stephen has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for small businesses, entrepreneurs, independent contractors, and freelancers. He is the author of over 20 books and hundreds of articles and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Among his books are Deduct It! Lower Your Small Business Taxes, Working with Independent Contractors, and Working for Yourself: Law and Taxes for Independent Contractors, Freelancers & Consultants.