What small businesses operate as sole proprietorships?
The main benefit of a sole proprietorship is its simplicity—you simply start working and report your income on your personal taxes. The main drawback is the lack of protection from legal claims, both for the owner and the business. For some businesses, however, the risk of incurring legal liability is so minimal that the benefits of a sole proprietorship outweigh the potential risks. Below are a few examples of businesses that commonly operate as sole proprietorships.
A photographer may work for individual clients, taking photos at events or on special occasions. Many do not have employees and perform all work themselves. In general, a photography business is low risk aside from travel to events, hiring help, and hosting photography sessions onsite. When a photographer begins taking on those responsibilities, or starts being hired by corporate clients for commercial work, a sole proprietorship may not provide sufficient legal protection.
A personal trainer who has their own business may work at their client’s gym, or home. While there can be some risk, liability in most situations will be associated with a personal injury likely covered by the personal trainer’s Release of Liability, purchased insurance, or their client’s health insurance. When personal trainers have their own facilities or hire employees, forming a separate legal business entity provides legal protection.
Freelance writer or artist
Creative freelancers have low potential for liability. They are usually independent contractors who work for a wide variety of clients or for themselves. The primary risks involve breach of contract and copyright infringement. Both of those situations are rare, so a sole proprietorship may make sense for these freelancers.
Housekeeper or cleaner
Housekeepers generally go into a client’s home to perform services. In most situations, if an injury on the job or property damage arise, the client’s homeowners or renters insurance covers the liability. Like a personal trainer, however, a housekeeper can still obtain their own liability insurance as well. Additionally, when hiring help for their business, forming a separate legal business entity provides legal protection.
Financial planning and bookkeeping
Financial advisors and bookkeepers also have relatively low-risk businesses when they work with individuals only. For those providing these services, however, purchasing professional liability insurance can be critical in case a claim does arise. In general, with the right insurance in place, and contracts that include liability waivers, a sole proprietorship can often meet the needs of these types of businesses, to a point. For financial professionals, however, it is important to seek out legal advice to ensure their specific business and personal assets are adequately protected.
What businesses benefit the most from being sole proprietorships?
Any low-risk business that has few or no assets can benefit from being a sole proprietorship. In addition, business owners who do not have significant personal assets may not have much to protect.
Some businesses not only have low potential for liability, but their assets are less likely to cause damage because they are fewer in number. For example, a construction company that operates heavy equipment is riskier compared to a freelance writer who sits at a desk and works on a computer.
Other risks you might consider as a new business include:
- Car accidents if you deliver or travel.
- Unsafe or dangerous products.
- Slip and fall accidents on your property.
- Employment claims (e.g., discrimination, wrongful termination, injuries at work).
- Employee or customer injuries.
- Property damage.
Businesses may also run the risk that they cannot complete a contract or other obligation. The damages that result from that breach of contract vary a great deal. For example, the damage associated with not getting a piece of content written as a freelancer is probably lower compared to not meeting a delivery deadline for a manufacturing component.
What businesses benefit the most from forming a corporation or LLC?
Business owners with significant assets and high-risk companies benefit the most from forming an LLC or corporation for their businesses. For example, forming a separate legal business entity might be a good idea if:
- Your business operates within its own real property (e.g., you have a dedicated retail store or office).
- You have employees.
- The business involves any dangerous or physical activities (e.g., shooting range, axe throwing, skating rink).
- The company creates or sells a product rather than provides a service.
- The business uses or owns heavy or dangerous equipment.
- The company requires a great deal of driving or travel (e.g., delivery services, cargo, or freight).
- There are specific laws and regulations that apply to your industry.
- Supplies or inventory are obtained on credit.
Business owners who own significant personal assets may want to form a separate legal business entity to protect those assets. In a sole proprietorship, there is no distinction between the individual owner and the business, so operating as a sole proprietorship puts all of your individual assets at risk.
When does my side hustle require setting up a business or paying business taxes?
The moment you start offering goods and services to others, you are running a business and are taking on liability. As a sole proprietorship, you are personally at risk if something goes wrong, and your business is at risk if something goes wrong in your personal life. Legally, there is no distinction between you and your business, unless you take steps to form an LLC or corporation. It can be helpful to complete a Business Entity Planning Worksheet to decide which type of entity is right for you and your business.
As part of the startup process, you may be required to apply for all applicable local and state permits and licenses. While you may not need to create a separate entity to do this, if you initially start as a sole proprietorship, you may need to go through the process again when you decide to form a separate legal business entity. The same is true when you apply with the Internal Revenue Service to obtain an Employee Identification Number if you hire employees.
As a sole proprietor, if you make $600 or more from your side hustle, you need to report it as income on your personal taxes. The reporting requirement involves filing a Schedule C on your individual return. Many small business owners are afraid of setting up an LLC or corporation due to the potential tax burdens, however, many LLCs and certain types of corporations are allowed to use similarly simple tax filings.
If you have more questions about the risks of running your business as a sole proprietor, reach out to a Rocket Lawyer network attorney for affordable legal advice. If you need tax help, Rocket Lawyer can now match you with a tax pro for affordable and convenient tax filing services. Don't do your taxes™ – Let us do them for you.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.