A sole proprietorship is an unincorporated business owned by one person who owns the company by themselves, according to the IRS. An individual who is the sole member of a domestic limited liability company (LLC) is not considered a sole proprietor if they treat the LLC as a corporation. In Alabama, a sole proprietorship is not required to register with the Alabama Secretary of State. A sole proprietorship must confirm the availability of a trade name if they plan to operate under a different name from the owner’s legal name.
Married Couples and Sole Proprietorships
A business must be a qualified joint venture under the IRS’s guidelines in order for both spouses to be considered sole proprietors. The requirements include: the only members in the joint venture are a married couple who file a joint tax return; the spouses own and operate the business as co-owners; both spouses materially participate in the business; and both spouses elect qualifying joint venture status on IRS Form 1040.
The spouses must divide income, gain, loss, deduction, credit and expenses in accordance with their respective interests in the venture. A qualified joint venture by a married couple is not considered a partnership for federal tax purposes. When one spouse is an employee of another spouse, the owner spouse must pay Social Security and Medicare taxes for them.
What a Sole Proprietorship Needs
The state of Alabama provides that the correct identification type for a sole proprietorship is a Social Security number. If a sole proprietorship chooses to hire employees, it must get a federal employer identification number (EIN).
Even if the sole proprietorship gets an EIN, the sole proprietor's Social Security number remains the appropriate identification type for the business. The business will not use its EIN number as the identification type. In contrast, the correct taxpayer identification type for a corporation, partnership or single member LLC is the business's EIN.
A sole proprietor will need to choose a business name, which can be a trade name. A sole proprietor must also secure a business license, as well as any necessary permits and zoning clearance. A sole proprietor should report profits and losses on their personal tax returns using Schedule C and submit a single return.
Doing Business As (DBA) Registration
A sole proprietor who wants to do business under a name other than their own can register a fictitious name for the company. The first step to the process is looking for the new name using the tool from the Alabama Secretary of State’s Business Entity Search. The objective is to make sure the new name is not already in use.
Application for a Service Mark
The sole proprietor then needs to complete an application for a service mark, trademark or trade name. A service mark is a word or combination of words that identify the services rendered. A trademark is a word or combination of words to identify goods made or sold. A trade name is a word or combination of words to identify the business. If the secretary of state rejects or denies the application, that does not prevent the sole proprietor from using the mark.
The rights of ownership of a particular mark are achieved through the common laws of adoption and usage rather than registration. If the secretary of state grants the application, the effective term for a mark registration is five years. A business can renew a mark six months before its expiration date. The sole proprietor should have samples of documents that verify the use of a mark. Good examples of such documents include business cards, brochures, flyers, labels and decals.
A business owner should submit three specimens of documents with the application for registration. The application should be notarized by a notary public. The application asks for the date that the mark was first used in Alabama. Note that a mark does not offer legal protection for the business’ assets if the business is sued.
Getting an Alabama Business License
A state business license in Alabama is typically referred to as a business privilege license. State and county licenses are issued by the county probate judge or license commissioner in the county where the business is conducted. A license is required in every county where the business is conducted, and a city such as Birmingham may require an additional business license. The Alabama Department of Revenue does not provide city licenses.
Application for Business Privilege License
When a sole proprietorship files for a business license with a county such as Jefferson County, it must provide the number of employees in that county. It must state the business’ trade name if it is different from that of the taxpayer. The sole proprietorship must share the address of the business in that county, as well as the type of business, such as manufacturer or retailer. The sole proprietorship must check all the taxes for which it is liable, such as sales tax, occupational tax, business license and alcoholic beverage tax.
City Business Licenses
A city may license all businesses, including sole proprietorships, that conduct trade or perform services within city limits. A new business license may be prorated by quarter-year increments. A city often issues different types of licenses, such as a general license, alcoholic beverage license or insurance company license. An applicant for a certain type of license, like a landscape architect or gardener, may need to show evidence of a current, valid license or certification by a city, county or state board.
In addition to providing proof of board licensure or certification, certain types of businesses, such as electricians, are required to post a surety bond with the city. The applicant must provide the original bond form containing original signatures before the license application can be completed.
An applicant who runs a business that requires a health department permit, such as a bar or a tattoo parlor, needs to present a health department permit at the time of application. A day care center must present a current, valid zoning certificate of operation and a valid day care license issued through the county or Alabama Department of Human Resources.
Pros of a Sole Proprietorship
A sole proprietorship is the simplest and most common business structure, according to the Alabama Small Business Commission. A sole proprietor has complete freedom to make decisions and retains more control than other types of owners. Sole proprietors can realize all of the profits of the business.
Income from the sole proprietorship is recognized as the owner’s income. A sole proprietorship is not taxed separately from the individual, so tax preparation is easier.
Cons of a Sole Proprietorship
A sole proprietorship does not create a separate business entity that protects the assets of the business. This means that the owner has unlimited personal liability for all debts. And, if a person wronged by a sole proprietorship sues that business, they can name the sole proprietor as an individual in the lawsuit. This means they can go after the owner’s personal assets. Also, it can be harder to raise funding for a sole proprietorship than for an LLC or corporation.
How to Hire Employees
A sole proprietor who hires an employee must classify the hired candidate as an independent contractor or employee. When the sole proprietor classifies a person as an employee, then the business must have an employer identification number. The sole proprietor now has tax responsibilities that include withholding, depositing, reporting and paying employment taxes.
A sole proprietor who hires an employee must gather certain information for their records: the employee’s eligibility to work in the U.S., the employee’s Social Security number, and the employee’s withholding information for federal taxes. An employer should keep employment tax records for at least four years.
When Sole Proprietors Go Bankrupt
When a sole proprietorship goes bankrupt, the sole proprietor can file for Chapter 7 bankruptcy. A Chapter 7 bankruptcy involves the court appointing a trustee to sell the debtor’s nonexempt assets. The trustee uses the proceeds to pay the creditors.
Filing for Chapter 7 bankruptcy may result in the loss of property. An individual debtor must complete a financial management course before they are eligible for a discharge. They must also file a certification of credit counseling and a copy of any debt repayment plan developed through credit counseling.
Alternatively, a sole proprietor can file for Chapter 13 bankruptcy to pay off their personal and business debts. A Chapter 13 bankruptcy involves keeping assets and making monthly payments to a court-appointed trustee. The trustee pays off the owner's creditors, typically for between three to five years.
Comparisons With LLCs and Corporations
Both LLCs and corporations are separate legal entities from their owners. When such businesses incur debt, the owner or shareholders are not personally liable for the debt. The owners can file for business bankruptcy, either Chapter 11 or Chapter 13, rather than Chapter 7. Owners of LLCs and corporations can be held personally liable for wrongs such as fraud and debts that they personally guarantee.
Circumstances that warrant “piercing the corporate veil” include an intention to pursue actual fraud and the corporation being an alter ego of a parent corporation or a shareholder.
Sole Proprietorship vs. Partnership
A partnership is a business owned by two or more people. Partners in this type of business should consider drafting a partnership agreement, which explains how the partners will share profits, losses and responsibilities. Just like a sole proprietorship, a partnership must obtain a business name, permits and licenses. A partnership does not shield its owners from liability.
When a partnership causes financial harm to another person, all the partners in the business can be held personally liable. Some partners may bear a greater amount of responsibility than others, but the plaintiff can name all the partners in a lawsuit.
When members of a partnership file taxes, they submit two returns with the Internal Revenue Service. The first is IRS Form 1065, which reports the income of the partnership as a whole. The partnership itself does not pay tax on its income. It “passes through” profits and losses to its partners. Each partner must also report their portion of profits and losses on their personal tax return using Schedule E.
Business Checking Accounts
A bank or lender usually requires certain people associated with the business to be present to open a business checking account. For a sole proprietorship with only one owner, only that owner must be present. For a spousal sole proprietorship, where the spouses both qualify as sole proprietors, both owners must be present.
For a sole proprietorship living trust, in which property is passed through to heirs without a probate proceeding, the trustee must be present. For a sole proprietorship with a power of attorney, in which an agent has power of attorney to act for the sole proprietor, only the agent must be present. A bank also typically requires a Social Security number, individual taxpayer identification number for a non-U.S. citizen or an employer identification number to open an account.
Closing a Business
A sole proprietor can make a decision by themselves to close the business. A partnership, LLC or corporation must make a decision that correlates with the guidelines in the company’s articles of organization. These entities should document the final decision with a written agreement.
When a sole proprietor closes the business, they should cancel all licenses and permits, along with the business’ trade name. As the sole proprietor pays their final income taxes, they should check the box that notes the document is a final return. They must also close their EIN account with the IRS. Closing the EIN account lets the IRS know the company will not use the number going forward.
- Alabama Department of Revenue: Frequently Asked Questions
- IRS: Sole Proprietorships
- U.S. Small Business Administration: How to Build Business Credit Quickly, 5 Simple Steps
- Alabama Secretary of State: Business Entity Records
- City of Birmingham: General Information for New Businesses
- Alabama Department of Revenue: Business Privilege License
- Alabama Secretary of State: Instructions for Application to Register Trademark, Service Mark, or Trade Name in Alabama
- Alabama Small Business Commission: Business Entities
- IRS: Businesses with Employees
- IRS: Hiring Employees
- IRS: Recordkeeping
- Jefferson County, Department of Revenue: Application for Tax or License Number
- U.S. Bankruptcy Court, Southern District of Alabama: Chapter 7
- IRS: About Form 1065
- IRS: 2020 Instructions for Schedule E
- Chase for Business: Who can open a business checking account?
- Alabama Small Business Commission: Steps to Closing a Business
- IRS: Married Couples in Business
- IRS: Frequently Asked Questions, Entities
Jessica Zimmer is a journalist and attorney based in northern California. She has practiced in a wide variety of fields, including criminal defense, property law, immigration, employment law, and family law.