No business entity is easier to start or faster to register in the state of Tennessee than a sole proprietorship. Since no formal registration filings are required, a businessperson can decide to open a sole proprietorship and hang up their shingle on the same day they make the decision.
Managing the business is also simple, since both business income and business debt are attributed to the owner personally.
There are some very real advantages to doing business as a sole proprietorship, but there are downsides, too. Anyone going this route in Tennessee needs to understand the pros and cons of a sole proprietorship before jumping in.
Sole Proprietorship: Going It Alone
What is a sole proprietorship? Sole mean one, and proprietorship means business. So the term might be defined as a business with just one owner.
Compare this to a partnership and it's easy to see the main advantage of this business form: it only takes one person to form a sole proprietorship – that individual is the owner and the boss. They make all the decisions for the business and exercise total control over the profits.
If a sole proprietorship makes money, all income belongs to the individual who owns it, sometimes referred to as a sole proprietor. If the business has debts, 100 percent of these are also allocated to the owner.
How Is a Sole Proprietorship Taxed?
A sole proprietorship business is, in a sense, invisible when it comes to taxation. That is, the Internal Revenue Service, as well as the Tennessee Department of Revenue, simply ignore the business structure of a sole proprietorship and treat the income from the business as if it were earned directly by the owner.
This can be beneficial, but it can also be a problem. If a small business nets $20,000, taxes on it are minimal and it is in a low tax bracket. But imagine that the business is a side hustle, and the owner earns $50,000 from a regular job.
If the business earns $20,000, that amount would be added to the $50,000 to give the individual owner taxable income of $70,000, putting them into a higher tax bracket.
Profit Is Taxed at the Individual's Tax Rate
Every dime of profit earned by the company is taxed at the individual tax rate applicable to their individual tax return. To make matters worse, the sole proprietor must pay the 15.3 percent federal self-employed rate for Social Security and Medicare benefits on their federal tax return, just as they do for any other self-employment income.
Debts of a Sole Proprietorship in Tennessee
What about the debts of a sole proprietorship? Just as all income from a sole proprietorship is allocated to the person who owns it, all debts of the business, as well as all expenses, are also the responsibility of the owner.
Like the allocation of income, the allocation of debt cuts both ways. The sole proprietor business owner in Tennessee is on the hook to pay all debts of the business. They have to reach into their own savings to pay for items they buy for the business. But the better news is that they get to write off expenses against their personal taxable income.
For example, if the owner of a sole proprietorship purchases a scanner for the business, it can be written off as a business expense. That gives the sole proprietor a legitimate way to lower the taxes they owe on their personal income tax returns, both state and federal.
Personality Liability for Debts
What happens if the sole proprietorship ends up with lots of debt and very little income? The business is one and the same as the sole proprietor, so the debt of the business is the debt of the owner.
When a sole proprietorship does not earn enough to pay off its debts, the owner is personally liable. This means that a business creditor can sue the owner personally for business debt and even put liens on their property and bank accounts.
An LLC Has Liability Protection
This factor represents the biggest difference between a sole proprietorship and a limited liability company (LLC). An LLC business form reduces and limits the personal liability of those who own it. If an LLC does not pay its debts in Tennessee, the creditor has no recourse against the owner personally. Their home and accounts are not at risk.
This personal liability is less important when the company is raking in income. But it becomes an important factor if the business buys a lot on credit that it cannot pay. All of the sole proprietor's income and assets can be attached to pay outstanding debts.
Creating a Tennessee Sole Proprietorship
While Tennessee does not require that a sole proprietorship be registered with the state, there are a few steps to take in order to set up the new business. These include:
- Select a legal name for the business.
- Obtain an EIN from the IRS.
- Determine if any licenses are required.
- Understand employee requirements.
- Look into retail sales tax.
Selecting a Business Name
Most businesses in Tennessee must select and register a business name separate from their own. But sole proprietorships in the state have unique rules. The business can operate under the name of the owner – Carlos Gomez can operate a cleaning business as Carlos Gomez Cleaners.
But the owner can also select another name under which to operate. This is called a fictitious business name, or a DBA. It can be "Cleaning Made Easy," or any other name that is not already taken by another Tennessee business.
Check for similar names at the name search page of the Tennessee Secretary of State's website. It is not necessary to file or register a DBA (doing business as) for a sole proprietorship, but it can be done through the Tennessee One Stop Business Resource.
Business Tax License Application Form
Before an individual sets up a fictitious name in Tennessee, the proprietor must file a Business Tax License Application with the county clerk’s office in the county where they plan to operate or conduct their business. Operating in several counties? Owners will need to repeat the process in each.
Get an Employer Identification Number
If the business plan for the sole proprietorship involves hiring employees, or even just one, the owner must obtain an Employer Identification Number (EIN) from the IRS. The employer's identification number is a nine-digit tax number. It is the business equivalent of an individual's Social Security number and is used to report employee wages for tax purposes.
If there are no plans to hire an employee, the company does not need to get an employer identification number. A sole proprietorship without employees simply files taxes under the owner's SSN. And nobody should abandon their dream of opening a sole proprietorship or refrain from hiring employees because of this requirement.
Getting an EIN is free and easy to accomplish. Simply apply for one online at the Internal Revenue Service website.
Check on Business License Requirements
Tennessee does not require a general business license for all business types operating in the state. However, some professions and occupations – think law or medicine – require a license. Tennessee's Department of Commerce provides a comprehensive website showing every profession and occupation that requires a license by a sole proprietorship.
Teo Spengler earned a JD from U.C. Berkeley Law School. As an Assistant Attorney General in Juneau, she practiced before the Alaska Supreme Court and the U.S. Supreme Court before opening a plaintiff's personal injury practice in San Francisco. She holds both an MA and an MFA in English/writing and enjoys writing legal blogs and articles. Her work has appeared in numerous online publications including USA Today, Legal Zoom, eHow Business, Livestrong, SF Gate, Go Banking Rates, Arizona Central, Houston Chronicle, Navy Federal Credit Union, Pearson, Quicken.com, TurboTax.com, and numerous attorney websites. Spengler splits her time between the French Basque Country and Northern California.