Many Texas business owners choose to start a sole proprietorship, as it is the quickest and least expensive business structure available. While no formal paperwork is required, there are other regulations that need to be followed and decisions that may have legal implications when not undertaken with care. It is key to understand how sole proprietorships operate and what this means for you as the owner before you take any steps toward starting your business.
What is a sole proprietorship?
A sole proprietorship is a business entity that refers to a business that is unincorporated and has 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 Texas
1. Choose your business name
Texas law allows you to operate a sole proprietorship under a name other than your own. While you can use your name, most people choose a specific business name. If you want to do this, you should first conduct a name search on the Texas Comptroller of Public Accounts database to see if the name you chose is taken or if something similar exists.
In Texas, 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 your business name is different from your own name, Texas requires you to work with the country clerk where you plan to do business in order to use an assumed business name. This requirement is mandatory and requires you to obtain an Assumed Name Certificate from the relevant office and then mail it to the country clerk at the address listed on each application. There is a small fee, around $10, that varies by county. No action needs to be taken at the state level.
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 Texas 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.
The only state level permit or professional license required by Texas is the seller’s permit or sales tax permit. Anyone engaged in business in Texas who plans to sell or lease tangible personal property or taxable services must obtain this license, including sole proprietorships. This permit can be obtained via the Texas Comptroller’s website. There is no filing fee to apply for a Texas sales tax permit and it does not need to be renewed.
Certain professions and industries may require additional permits through the state.
Depending on the location of your business and what industry you are in, you may need to obtain separate licensure on a local level. For example, the City of San Antonio requires anyone who sells items door-to-door or in a public space to obtain a Peddler’s License.
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 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 Texas 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 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, 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 proprietorship.
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What are the benefits of being a sole proprietor in Texas?
Simple way to start a business
Texas 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 advice, 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 setting up 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 debts.
How are sole proprietors taxed in Texas?
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 income tax on all of the income listed on their personal return, including income from business activity at the applicable rate for the year.
Texas does not have a state income tax, so no additional income tax is imposed beyond the federal amounts.
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 property tax rate in Texas is an average of 1.69%, slightly higher than the national average.
Business taxes in Texas are some of the lowest in the country. Texas does not require sole proprietors to file or pay franchise taxes. However, any business with employees will have to pay unemployment taxes each year.
Most businesses in Texas, including sole proprietorships, will require a sales tax permit. This is also known as a seller’s permit as it allows a business to sell products and services to the public and to collect sales tax on these goods. If you are a digital business but sell products within Texas, this will also be required.
Each business should have one assumed name or DBA, however, there is no limit to the number of businesses you can operate under an assumed name. Keep in mind that each one will require incremental expenses and paperwork that needs to be filed, renewed, and maintained.
You can not use the words lotto or lottery, or any words that imply the company is organized for an unlawful purpose. You can also not use names that would confuse your business with a government agency or anything that implies you are working for the benefit of veterans or their families, such as “legion” or “world war.” Other words will be restricted based on the type of business you run. For example, you cannot use the word “Attorney” unless there is a licensed attorney at the helm.
In Texas, sales tax can be applied to any physical property, such as furniture or motor vehicles. Tax-exempt goods include groceries, gasoline, and non-prescription medication. Anything that is digital in nature does not have sales tax applied in Texas unless it is prewritten computer software being sold online. The Texas sales tax is levied at a rate of 6.25%.
Income taxes are done at the federal level and should be filed according to the regular schedule For state sales tax, the frequency of filing depends on the total amount of sales tax collected. If less than $83.33 is collected per month, annual filing is permitted. More than $1,500 per month means you should file monthly.
An EIN Is a business equivalent of a Social Security Number and is used by the IRS to track taxes. Because sole proprietorships are taxed under the owner’s personal taxes, an EIN is not required to operate or file taxes. However, it may be beneficial to have an EIN if you are planning to open a business bank account, obtain insurance, or seek outside funding.
Texas does not require paperwork to become a sole proprietor and no associated fee. If you want to operate under a name other than your own, you will need to file an Assumed Name application at the county clerk’s office and pay a small fee, but this is not required.