California has a lot to offer business owners. You may be tempted to start a sole proprietorship right away, but you need to look at some of the state rules first.
California has specific rules about how to file a trade name and its taxes vary from other states. Our guide below will help you as you plan your sole proprietorship in The Golden State.
What is a sole proprietorship?
A sole proprietorship is a business entity in which the business is unincorporated and has a single owner. For tax and legal purposes, the business and the owner are considered the same entity. This is the simplest version of a business that one can form, and many people who freelance or sell goods are operating as a sole proprietor without realizing it. Because there is no separation between the business and the owner, the owner is personally responsible for all debts and litigation that the business is named in.
Who is a sole proprietorship best for?
By definition, a sole proprietorship is a business with a single owner. Anyone looking to form a partnership or have multiple owners should choose a different structure. A sole proprietorship will be a good fit for someone looking to maintain total ownership of their business who is willing to take on the liability associated.
Because a sole proprietorship is simple to start and requires no fees or paperwork, it can be a good option for anyone who needs to get a business up and running quickly. It can also offer a good test case for a business idea without any upfront requirements.
It can be more difficult to get funding and credit in a sole proprietorship, so if investments are required, having capital at the start can make this structure easier.
How to set up a sole proprietorship in California
1. Choose your business name
California law allows you to operate a sole proprietorship under a name other than your own legal name. While you can use your name, most people choose a specific business name. If you want to do this, you should first search the California Secretary of State’s website to check on name availability.
In California, a business name must not:
- Match any other business name in the state
- Be misleading
- Use any certain government agency terms or abbreviations like FBI or EPA
You might also consider checking your name with the trademark office and the U.S. patent office.
2. File a trade name
Filing a doing-business-as (DBA) name or what is also called a fictitious name or trade name can’t be done on the state level in California. The state has no registry of DBA names. Those wanting to start a sole proprietorship with a trade name must file it on the local level with a city or county where the business is located.
3. Obtain licenses, permits, and zoning clearance if needed
Depending on the industry of your business, you may need to obtain a variety of business licenses or permits. This is managed by the California Department of Business and Professional Regulation (DBPR), though some areas like health care are licensed by independent areas.
You should also explore local regulations like building permits and zoning clearances where appropriate.
California doesn’t require a general business license for those who operate a sole proprietorship but local cities and counties may depend on their laws.
The state does require a professional or occupational license for those in 200 different jobs including barbers, teachers, security guards, contractors, nurses, and attorneys.
The state has a complete list of those who are required to have professional or occupational licenses.
4. Obtain an Employer Identification Number (EIN)
If you’re planning a new hire, you need to obtain an EIN. This nine-digit number is issued by the IRS and used for tax purposes when you need to report wages. (It’s also called a federal employer identification number). You can file for an EIN online through the IRS website.
If you do not have employees, you can use your Social Security Number to file taxes and are not required to have an EIN. However, some banks will require new business owners to have an EIN to open a business bank account, so you may want one anyway.
Once you have these pieces in place, your business is ready to operate! You can begin thinking about things like marketing materials, landing your first clients, and how you want to grow over time.
How is a sole proprietorship different from an LLC or freelancing?
Anyone who does work on a freelance basis can technically be considered a sole proprietor of their business. They will pay taxes individually and usually operate under their own name, assuming liability associated with their work. However, there are a number of ways the two can differ.
A sole proprietor is able to hire employees and is responsible for employment taxes, while a freelancer usually cannot do this without filing paperwork and effectively becoming a sole proprietor. Freelancers also do not have to adhere to the same local regulations that a business might and cannot purchase the same types of insurance. A freelancer is considered somebody who has a relationship with external clients, while a sole proprietorship operates as a small business.
In contrast, an LLC is another possible business structure for small businesses. An LLC, or limited liability company, must file articles of organization and register with their state. This also protects the owner (or owners, as an LLC can have multiple) from personal liability, and the business is treated separately for tax purposes. Because of this separation, LLCs are often given larger lines of credit or more likely to attract future investments in times of growth.
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What are the advantages of a sole proprietorship?
Fast and inexpensive startup
Unlike other business structures, a sole proprietorship does not have to register with the state or pay the associated fees. If a fictitious name is being used, there may be a registration process for the trade name, but it is optional. This lack of paperwork and cost means that you can start a sole proprietorship almost immediately and without bureaucracy.
In a sole proprietorship, all profits and losses for the business are included in the owner’s individual tax returns. This leaves the owner responsible for state, local, and federal taxes that include their business, but they are not subject to corporate tax rates or specific business taxes. Additionally, being self-employed offers tax credits and benefits to the owner.
Complete control over your business
The sole proprietor of a business has complete control and is responsible for all decision-making within the business. With no partners or shareholders, you are free to run your business as you choose and take risks without implicating others.
What are the cons of a sole proprietorship?
Because the owner and the business are the same in a sole proprietorship, it can leave the owner vulnerable in multiple ways. Any debts that the business owes are also considered personal debt, and any lawsuits against the business also implicate the owner. If these result in collections or seizures, the owner’s personal property can be taken in order to meet the obligations of the business.
Difficulty with funding
If a sole proprietor wants to raise capital, they may have fewer options to do so. Without stock in the business to sell, investors are less likely to get involved. Banks may also be less inclined to offer credit because the owner will be responsible for the loans in the end.
Risks of hiring employees
As long as they have a valid Employer Identification Number, a sole proprietor is able to hire employees as needed. However, if any legal issues arise related to an employee, it could put a strain on the owner as their own personal assets are on the line for lawsuits and other costs.
How are sole proprietors taxed in California?
With this type of business, taxes are a part of the personal tax return of each owner. Business profit is calculated and reported on a Schedule C form which is for Profit or Loss from Small Business.
A Schedule C will calculate the income of the California business, including all income and expenses, along with the costs of goods sold and costs for home-based businesses. The rest of the calculation is the net income, which is the amount of taxable business income.
This net income is entered on the Schedule C and included with other income and losses the owner (and their spouse) report for the purpose of income taxes.
The owner then pays income tax on all of the income listed on their personal return, including income from business activity at the applicable rate for the year.
Sole proprietors in California don’t have any additional taxes to pay because you are paying as an individual taxpayer. Your tax is based on your total income, including your proprietorship business. However, California has the highest marginal income tax in the nation.
The California income tax rate goes from 1% to 12.3%. California also sets fees it adds to incomes starting at incomes of $9,326 in addition to the percentages. Those making $9,326 will actually pay $93.25 plus 2% of their income in taxes.
The highest bracket of those making $625,370 will pay $60,789.92 plus 12.3% of their income in taxes.
As a self-employed individual, there are additional taxes necessary to pay. Based on the business’ income, the sole proprietor must pay Social Security and Medicare taxes. If the business operates at a loss, the tax is not payable, but you will not receive benefit credits for that year.
There may be other employment taxes and property taxes that are applicable.
The California sales tax is 7.25% and business owners, even sole proprietorships, are expected to collect it and send it to the state. Those hiring employees are expected to make certain payroll deductions for the state including unemployment insurance, employment training tax, state disability tax, and personal income tax.
Employers must pay half of those taxes and withhold the other half from paychecks.
Sole proprietors are also expected to pay any property taxes associated with a building owned or operated by the business.
No, there isn’t any special licensing involved for those who want to start a sole prop in California. It remains an easy way to strike out on your own with few obstacles.
No, sole proprietorships are not a legal entity so registration isn’t necessary for taxes or permitting. However, you need to check with the local municipality where you’re located to find out if you need a business permit.
Regardless of how you do business in California, you will need a unique trade name just as any other business.
You will still need to file a personal tax return for both the federal government and the state but you won’t report any income from the business since there isn’t any.
Lost money from your sole prop is reported on your income tax return and you will get credited for that.
Most advise to pay taxes quarterly on any sole prop business to avoid a large tax bill in April. That is especially true for those working and living in California.
Taxes are paid to the California Franchise Tax Board as well as the IRS by filling out the proper IRS forms. Due dates are April 15, June 15, September 15 and January 15.
You can hire W-2 employees and you can hire people working as independent contractors.You will need an EIN to hire W-2 employees and independent contractors will need to fill out an W-9 form.
You can make any amount you want since you keep all the profits. However, financial advisors say that those who make more than $80,000 a year should start a single-member LLC instead for tax and legal purposes.
You will need to check with the state to see if you need a professional license. The Professional Licensure Guide is a place to start.
While a separate bank account isn’t required if you are doing business in your own name, it is advised in order to control spending for the business versus personal bills. You will need one if you have a DBA name.
Yes, you may handle paying yourself any way you like with a sole prop but it must be informally. You can’t pay yourself wages where you receive a W-2. However, you must report all the profit your business earns on your tax returns whether you receive it or leave it in the business bank account.