Choosing to go into business for yourself is an exciting, yet nerve-wracking, endeavor. Many people plan for years to be able to take these steps. One of the first important things you will do is determine your business structure and go through the proper registration with the state of Pennsylvania. For those choosing a sole proprietorship, read on to learn more about what this structure means and what you need to do to set up this form of business.
What is a sole proprietorship?
A sole proprietorship is a business entity that refers to an unincorporated business with a single owner. This is the simplest possible structure to set up a business. While there can only be one owner, a sole proprietorship can have employees and obtain an Employer Identification Number (EIN).
As a sole proprietor, your business profits are taxed as a part of your personal income. This makes the process simple, but can also expose you to personal liability in some cases.
Who is a sole proprietorship best for?
A sole proprietorship makes sense if you:
- Plan to start a business where only you are in charge and intend for that to be the case going forward.
- Want to call your business something other than your legal name.
- Plan to hire employees
- Want to set up a business quickly
How to set up a sole proprietorship in Pennsylvania
1. Choose your business name
Pennsylvania law allows you to operate a sole proprietorship under your own name or under a business name. While you can use your legal name, most people choose a specific business name. If you want to do this, you should first search the Pennsylvania Department of State’s website to see if the name you chose is taken or if something similar exists.
In Pennsylvania, 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
2. File a trade name
If you choose not to operate under your legal name, Pennsylvania requires a fictitious business name to be registered through the Secretary of State. This requires you to fill out a Fictitious Business Name Registration Form from the Department of State and to pay a $70 filing fee.
You must also publish an advertisement of your fictitious business name in both a newspaper and a legal publication within the county where you intend to do business. Proof of this does not need to be submitted to the Department of State, but should be kept in your business records.
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 Pennsylvania Bureau of Licensing and Occupational Affairs, though some areas like health care are licensed by independent areas. Professional licensing boards are categorized as either “Business-Related Boards” or “Health-Related Boards”.
Pennsylvania requires a general business license in order to operate a business in addition to these industry-specific permits. Any business that sells the property or performs services that would be subject to sales tax must also obtain a seller’s permit through the state. Cities may have additional requirements. For example, anyone doing business in the City of Philadelphia must have a Commercial Activity License.
You should also explore local regulations like building permits and zoning clearances where appropriate. These can be issued by a township, borough, city, or county depending upon the location of your business. Contacting your local municipal offices is the best way to understand exactly which regulations you may be subject to following
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. 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 own 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?
A Pennsylvania LLC is a limited liability company that can be formed by one or multiple people. The primary difference in an LLC is that it is a separate legal entity from the owner. In other words, your business and your personal assets are separate. With an LLC, taxes are filed separately and the business’ liability does not translate to the owner.
Setting up a sole proprietorship is simpler than setting up an LLC because it does not have the same business tax implications.
If you’re freelancing, you might wonder if you need to set up a sole prop. If you plan to hire independent contractors, then yes. To hire others, you need a business structure like a sole proprietorship.
If you don’t plan to hire anyone, you can continue to freelance and pay taxes on the income without setting up a sole prop.
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What are the advantages of a sole proprietorship in Pennsylvania?
Simple way to start a business
Pennsylvania sole proprietorships are incredibly easy to set up and do not require any filing process or fees at the outset. In fact, if you have done any freelance work or made money through a side hustle, you are technically operating a sole proprietorship. The simple and inexpensive start means you can quickly legitimize any business you are doing by opening a bank account and distributing formal marketing materials.
Your business remains yours
As the owner of a sole proprietorship, you have complete control of your business. Decisions will not need to take into account legal partners, shareholders, or partners, giving you the freedom to change your course or adjust as you learn about your business.
Easy transition to a corporation
Starting a business as a sole proprietor does not mean you will have to operate that way through the life of your business. At any time, you can convert a business to an LLC, corporation, or general partnership with the right paperwork and process. This allows you to feel out your business and settle on a model before you move to a corporate structure.
What are the cons of a sole proprietorship?
No personal asset protection
In a sole proprietorship, you are considered the same entity as your business, which means you are liable for any financial aspects of your business. If the business has a financial obligation that can’t be met, your personal money and property can be used to meet that obligation.
Less access to funding
A sole proprietorship may not be given the same access to business accounts and lines of credit as an LLC or a corporation. Government grants and funds awarded to small businesses are usually not available for sole proprietorships. You may also experience problems raising capital in the beginning since a sole proprietorship doesn’t carry the same credibility as an LLC or corporation.
Harder to sell your business
If your business grows to a place where you are profitable and have others interested in taking ownership, being structured as a sole proprietorship can present challenges. You would be subject to capital gains tax as part of the transaction, and any buyer would also be assuming liability for business debts.
How are sole proprietors taxed in Pennsylvania?
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 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 personal income tax on all of the income listed on their personal return, including income from business activity at the applicable rate for the year.
In Pennsylvania, sole proprietors will report income on a PA Schedule C (Profit or Loss from Business or Profession Form) for each business. This is then reported on a PA-40, PA Income Tax Return Form which is used to pay taxes at the state level. The state income tax rate of 3.07% applies in these cases.
If your income is expected to exceed $8,000 annually and is not subject to withholding by a Pennsylvania employer, you may also be required to make estimated tax payments throughout the year. These must be filed and remitted by the 15th day of April, June, September, and January each year.
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.
Any business selling taxable goods and services must also obtain a seller’s permit which allows them to collect and remit sales tax. This includes digital goods and services that relate to the building, repair, or maintenance of a taxable item. There is no fee for this permit but it is required in order to operate most businesses. The state does exempt certain items from this tax, such as candy, gum, food that is not ready to eat, clothing, and other goods.
There may be other employment taxes and property taxes that are applicable. The average effective property tax rate in Pennsylvania is 1.58%.
By default, a sole proprietorship will always operate under the full legal name of the sole proprietor. If you choose to file a trade name, it must be a name that has not been used by another business.
In addition, a sole proprietorship cannot include a business entity suffix like LLC or Incorporated that implied a different business structure. They can also not include terms used by financial institutions like “bank” or “credit union”.
A registered agent is a person filed with the state who is responsible for all correspondence and documentation regarding a business. While this is required for other structures like an LLC, a sole proprietorship does not have to name a registered agent.
The only state-level licensure required in Pennsylvania for all businesses is the sales tax license or seller’s permit. Any business in Pennsylvania that intends to sell or lease tangible personal property or certain services that would be subject to sales tax at a retail location must obtain a sales tax license. This is issued through the Department of Revenue and must be renewed every 5 years.
A sole proprietorship does not need to obtain an Employee Identification Number or EIN as long as they do not have employees. In this case, the owner will file their personal taxes under their Social Security Number. However, some banks will require one to open a business account. If a sole proprietorship does have employees, they will need to obtain an EIN in order to report to the IRS.
Most people are able to start a business without the help of an attorney and it is not required to have legal counsel. However, it can offer additional protection to use an attorney when filing for a fictitious name, applying for licenses and permits, and handling taxes. Because a sole proprietorship places all liability on the owner, it may be advisable to use an attorney and ensure nothing is done out of compliance.