The responsibility of business ownership begins well before you sign your first client or open your doors. In order to stay operational, you need to comply with all federal laws, as well as state and local ones.
In South Dakota, a sole proprietorship is a simplest and fastest way to establish your business, though you must still take certain steps with the state. We’ve outlined exactly what you need to know to start a sole proprietorship in South Dakota so that you can get your business up and running without worry.
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 South Dakota
1. Choose your business name
South Dakota law allows you to operate a sole proprietorship under a name other than your own 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 South Dakota Secretary of State’s website. to see if the name you chose is taken or if something similar exists.
In South Dakota, a startup 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
- Use a business entity suffix, like LLC, where it is not accurate
2. File a trade name or fictitious name
While a sole proprietorship is officially listed under your legal name, South Dakota allows you to file a DBA (doing business as) to claim the name for your business. South Dakota has a separate database for DBA names where you can search to ensure a name isn’t taken, but unlike formally registered names, these are not legally protected from being used elsewhere. Instead, it is simply good business practice to ensure no one else is operating under the name you plan to use.
Once you have chosen a DBA, it can be filed with the Secretary of State through their website. There is a $10 filing fee to do so, but the DBA will only need to be renewed every five years.
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 South Dakota Department of Business and Professional Regulation (DBPR), though some areas like health care are licensed by independent areas.
Not every business in South Dakota will require a license as there is no general requirement throughout the state. However, most businesses will need a license to collect and remit sales tax, and others may have industry-specific licensing requirements.
The main permit at the state level is a sales tax license, also called a seller’s permit. If your business has a physical presence in South Dakota, you must obtain this permit through the Department of Revenue. Doing so allows you to collect sales tax on behalf of the government and pay it out accordingly. There is no fee for this license and it does not need to be renewed once you have obtained it.
You should also explore local regulations like building permits and zoning clearances where appropriate. Some cities have more general requirements, while others will have city licenses necessitated for a variety of industries.
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, you officially have your own business! 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 South Dakota 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 freelancers or other 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 South Dakota?
Simple way to start a business
South Dakota 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 South Dakota?
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) reports for the purpose of income taxes.
The owners make tax payments on all of the income listed on their personal return, including income from business activity at the applicable rate for the year.
However, South Dakota is one of just a few states that do not implement an income tax. While the owner of a sole proprietorship will still need to pay all federal income taxes, the state will not also take a portion of their personal earnings.
To make up for this revenue, the state implements higher sales tax rates, particularly on items like cigarettes and alcohol. While the base sales tax is 4.25%, municipalities are able to add up to 2% in local sales tax in addition to a 1% municipal gross receipts tax on a range of establishments.
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 average effective property tax is 1.22% in South Dakota.
Even if a sole proprietorship has employees, they will not need to file for withholding in the state because there are no income taxes to be withheld.
Any business in South Dakota with a physical presence must obtain a seller’s permit. While some other states limit this requirement to those who can actually levy a sales tax, which excludes a small number of businesses, South Dakota has a blanket requirement. However, there is no fee and no renewal, so the process is simple.
While a sole proprietorship can only have one owner, they are able to have as many employees as they would like without changing the structure of the business. If there are any employees, the business may need to file for special licensing and ensure they are properly insured and following any federal withholding laws applicable to their business. This will also require an EIN.
An EIN, or employee identification number, is issued by the IRS at a federal level for tax purposes and sole proprietorships only need one if they have employees. Some states have an equivalent of the EIN, but because South Dakota does not have corporate or income taxes, they do not have their own number. A sole proprietor can use their personal Social Security Number for all tax purposes.
Most physical goods are subject to sales tax in South Dakota, like furniture and cars. Prescription medication and gasoline are exempt. South Dakota is unique in that almost all services are taxable, with construction being the only exempt service. Digital goods and services are also required to collect sales tax in the state.
While a sole proprietorship must register an assumed name or DBA with the state, this does not actually stop other businesses from using the name. There is a registry to search for other DBAs to avoid confusion in the market, but a DBA is not enforced by South Dakota as it is in some other states. To ensure no one uses your business name, you may want to look into a trademark.