The Legal Requirements for a Sole Trader

Prior to the formation of a business, an entrepreneur has to select a business structure. A sole tradership or proprietorship is a business entity owned by one person; the business and the sole trader are one legal entity. A sole tradership is considered the easiest business structure to form due to the limited number of legal formalities that govern its formation and the small amount of capital required to start the business. However, there are certain legal formalities a sole trader needs to adhere to.

Do You Need a Business License?

Many entrepreneurs have to obtain a business license before they can legally operate a business, and this applies to sole traders. A sole trader should first consult with the clerk in his county to obtain information on any licenses required to operate the business in the locality. He can obtain the necessary license application forms from the county clerk.

In some cases, the county and city both will require licensing to operate within their limits. Always check with both municipalities to ensure your business is legally named and licensed within the country and city when required.

Special permits are required for certain business models and a liability insurance policy and bond may also be necessary. A simple, work from home style business is often easy to run without any bonds or additional permitting so long as the location qualifies for commercial use.

Read More: Difference in Business License & Registering a Business

What's in a Name?

Sole proprietors are under no obligation to select a trade name for their business, when they embark on setting up the enterprise. However, if the business owner chooses to operate the business under a fictitious or assumed business name, she has to register that business name with the clerk in her county office.

In most areas, operating under a different name requires a DBA or Doing Business As license. This simply tells the municipality that the individual is doing business under a different name while remaining as a Sole Proprietor.

Who Pays the Taxes?

A sole trader has to ensure his business meets the state and federal taxation requirements. Due to the fact that legally, a sole tradership and a sole trader are a single entity, the sole trader bears the taxes of the business. This means the profits and losses incurred in the business fall under the personal income tax section and are filed under his IRS Form 1040, Schedule C.

As a sole proprietor, he can use his Social Security number to report on taxes, but if he has employees, a certified retirement plan or pays excise taxes such as firearms taxes, the sole trader requires a federal employer identification number (EIN).

What About Self-Employment Tax?

A sole proprietor has the responsibility to pay self-employment tax, that is, Medicare and Social Security taxes, because she is the owner of the business. The business owner has to present to the IRS the principal business code to identify her business structure.

When reporting her taxes the business owner only pays her self-employment tax once despite the number of sole proprietorship she owns. However, if the net profits resulting from her businesses are less than $400, she is not liable to pay self-employment tax. The self employment tax liability varies according to the number of write-offs and the income bracket. An assumed 20-30 percent liability is very normal.

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