A sole proprietorship is an unincorporated business owned by a single individual. The sole proprietor and business are considered one single entity under the law, unlike a corporation or partnership. Sole proprietors, like other business owners, can hire employees to fulfill their business' tasks, as long as they follow appropriate labor and tax laws.
A business operating as a sole proprietorship has many of the same powers as other business entities, as long as business affairs are properly conducted under the name of the owner or through a registered DBA or trade name. Sole proprietors report all of their business income and expenses on Schedule C of their personal Internal Revenue Service Form 1040 income tax return. Money paid to employees is a deductible business expense that reduces the sole proprietor's Schedule C reported profits and tax liability.
Any individual can become an employer, even if it's not in a business context. For example, a person who hires a housekeeper or babysitter is an employer, but simply hiring an employee for personal purposes does not constitute a business expense and would not be tax-deductible in the same manner that employees of a sole proprietorship would be.
Licensing and Permits
Sole proprietorships must comply with state and local business licensing and permit rules. These laws may require sole proprietors to obtain business operation licenses or permits to comply with local land use, zoning or noise ordinances. If your sole proprietorship is a home-based business, like half of the businesses in America, local land use regulations may tightly restrict the number of employees you can have on the premises, or restrict parking for employees and customers. You may need to relocate your business to a commercial zoning district before you can engage employees.
Employer Identification Numbers
A sole proprietor who wishes to hire employees must register as an employer with the Internal Revenue Service and obtain an Employer Identification Number, or EIN. An EIN is the business equivalent of a personal Social Security number and is used to identify your sole proprietorship on all tax filings. You will also need to register the business with your state tax authority, which may issue a separate state tax identification number for your business. Most states' employment laws require you to report all new hires to a state tax or labor agency.
Tax Obligations and Advantages
A sole proprietorship, like any other business entity, must pay state and federal employment taxes for all employees, including payroll taxes, federal and state employee income tax and Medicaid withholding tax, in addition to the proprietor's self-employment tax. You must also correctly classify and file necessary tax reporting documentation for all independent contractors. One hidden tax advantage of a sole proprietorship is that you can employ your minor children and not pay any payroll taxes on their compensation. This feature can save a family a few thousand dollars a year in taxes and is not available to any other form of business entity. A sole proprietor who employs her spouse may also realize significant tax advantages relative to Healthcare Reimbursement Arrangements.
Read More: Tax Advantages of a Single Owner LLC Business Entity
- Citizen Media Law Project: Becoming a Sole Proprietor
- Internal Revenue Service: Sole Proprietorships
- Business Know How: The Big Hidden Tax Benefits of Sole Proprietorship
- Poznak Law Firm Ltd.: Doing Business as a Sole Propriotor
- U.S. Small Business Administration: Zoning Laws for Home Based Businesses
A freelance writer since 1978 and attorney since 1981, Cindy Hill has won awards for articles on organic agriculture and wild foods, and has published widely in the areas of law, public policy, local foods and gardening. She holds a B.A. in political science from State University of New York and a Master of Environmental Law and a J.D. from Vermont Law School.