Are You An Independent Business Owner or a Sole Proprietor?
As You have a solid business plan, a great work ethic, and the skills and confidence to find clients and work for yourself.
Congratulations! You’re an entrepreneur.
But what kind of entrepreneur are you?
Independent business owner?
There are all different types of small business owners, and knowing which one you are is important for many reasons.
Independent Business Owner vs. Sole Proprietor: What’s the Difference?
When you hear someone say “independent business owner,” they may be referring to one of two things:
- An individual who owns a small business
- Someone who is an owner of an independent business
Let me explain …
An independent business is any business that is privately owned and not publicly traded on the stock market. It can have one owner or many. It can be a massive operation with thousands of employees and a board of directors, or it can be a solo venture.
For example, Sir James Dyson is the one and only owner of Dyson, the company that makes those awesome vacuums and fans. Although it has an annual revenue of $8.2 billion and more than 13,000 employees worldwide, Dyson is a privately owned business that is not publicly traded.
So, you could technically call Sir Dyson an independent business owner.
That’s not the type of independent business we’re talking about today.
We’re focusing here on businesses run, owned, and (in most cases) operated by one person. You’re about to learn how to tell if that one person is a sole proprietor or an independent owner of a business.
What Is an Independent Business Owner?
As a freelancer or gig worker, you are an independent contractor, which means you are an independent business owner.
What makes you an independent contractor is the fact that you are not on anyone’s payroll. You do not receive a W2 when it’s time to file your taxes at the end of the year. Your clients issue 1099 forms for you to submit at tax time as a way to show how much they’ve paid you for your services.
Sometimes, independent contractors hire other independent contractors when they need additional help.
Independent contractors also have the option to form an LLC or an S-Corp, both of which offer their own financial benefits.
In an LLC — a limited liability corporation — your personal finances and business finances are separate entities.
An S-Corp, or S-corporation, is similar to an LLC in that it provides limited liability protection, but it also helps to reduce self-employment taxes.
What Is a Sole Proprietor?
Understanding the differences between sole proprietorship and independent business ownership can be a bit tricky. That’s because sole proprietorship is the default term used by the IRS to describe anyone who owns a business by themselves.
In some cases, you can be both a sole proprietor and an independent business owner at the same time.
To be a sole proprietor, you must be the one and only owner in your business — you cannot protect your new business with an LLC designation. Your startup cannot register as an S-corp because sole proprietorship prevents you from being a corporation.
Sole proprietors may or may not receive 1099s from clients. In many cases, they receive earnings from the sale of products or services. You need to track those earnings, along with expenses, throughout the year in order to file taxes.
If you do receive 1099s, you are both a sole proprietor and an independent contractor at the same time.
Both independent contractors and sole proprietors are self-employed business owners. The distinction has nothing to do with your cash flow, the type of work you do, or how you manage new business opportunities. The biggest difference between the two is how you’re taxed and how you pay taxes.
The Pros and Cons of Being a Sole Proprietor
Is it to your advantage to be a sole proprietor or an independent business owner?
Here are the pros and cons of sole proprietorship to help you decide if this is the right business model for you:
PRO: You Do Not Have to Register Your Business With Your State
As a sole proprietor in charge of your own business, you do not have to register your business with the state. You can file your taxes under your social security number since you comingle your business and personal finances.
As long as you don’t have any employees on your payroll, there’s no need to register your business or obtain an EIN (employer identification number).
PRO: Setting Up a Sole Proprietorship Is Easy
According to the U.S. Small Business Administration, “no formal action is required to form a sole proprietorship.” As long as you own your own business, work for yourself, and have no team members on your payroll, you are automatically a sole proprietor.
Depending on the state you live in and the type of work you do, you may be required to obtain a business license or permit. If you sell taxable goods or services, your state tax authority will insist that you have a permit to do so.
If you choose to, you can create a business name or trade name, or you can use your own name. Since you file as a sole proprietor, you file your business taxes as part of your personal taxes. You decide whether or not you want your business entity to be recognized by your legal name or another moniker.
Becoming a sole proprietor is a low-cost (and oftentimes no-cost) way to establish your business.
PRO: Business Losses Can Offset Other Income
If you’re married and file taxes jointly with your spouse, business losses from your sole proprietorship can be used to offset other tax obligations.
For example, if your spouse works as an employee, receives a W2, and has taxes withheld throughout the year, losses from your business can offset your spouse’s income, resulting in a larger tax refund or a lower tax obligation.
CON: Your Personal Finances and Business Finances Are One and the Same
If someone sues your business, they’re suing you, which means your personal assets are at risk.
With an LLC, your personal assets are safe because they’re unrelated to your business. We’ll get more into this in the next section.
CON: You Have to Pay More in Taxes (and Pay More Taxes More Frequently
Sole proprietors have to pay quarterly estimated tax payments throughout the year. Failure to do so will result in penalties and fees from both the IRS and state tax authorities.
Sole proprietors also have to pay the self-employment tax, which is 15.3% of your net earnings. This tax goes toward the Social Security tax and Medicare tax, which would be partially paid and withheld by your employer if you were on a company’s payroll.
Depending on your state and locality, you may also have to pay additional taxes. For example, sole proprietors in Philadelphia have to pay the Business Income & Receipts Tax, an additional 6.2% tax on taxable net income.
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The Pros and Cons of Being an Independent Business Owner
Whether you run your small business as a sole proprietorship or an independent business, you’ll see that they have similar pros and cons.
But, opting to be an independent business owner affords you one major benefit that sole proprietorship excludes you from:
Setting up an LLC.
Many independent business owners choose to structure their business as an LLC, and that’s because LLCs have unique privileges that other business models do not.
As a Limited Liability Corporation, your business finances and personal finances are completely separate entities. In the event that your business gets sued or you default on a business loan and have to pay back creditors, your personal assets (home, car, savings account) are protected.
Creditors and those seeking damages cannot seize your personal assets if you’re set up as an LLC.
By forming an LLC, you also have the option to transition from being an independent business owner to a business owner/partner. LLCs can have multiple owners, so if you decide you need to take on partners to grow your business, you can do so. If you decide to take on business partners as a sole proprietor, you’ll no longer have a sole proprietorship.
How to Set Up an LLC
Becoming a sole proprietor takes zero effort on your part. Turning your independent business into an LLC does.
Here are the key steps required to make your independent business into an LLC:
- Register your business name.
- Choose a registered agent to receive all correspondence for your business.
- File articles of incorporation with your state’s Secretary of State.
- Request an EIN for tax filing.
- Create an operating agreement.
- Set up a business checking account that’s separate from your personal account.
LLCs offer a variety of benefits. Protection of personal assets is the most coveted benefit that LLCs provide.
How Independent Business Owners and Sole Proprietors File Taxes
The type of business system you adopt will determine how you file your IRS income taxes.
Both independent business owners and sole proprietors are self-employed, so both report their earned income on IRS form Schedule C.
If you’re new to the world of self-employment, you can forget about filing those 1040-EZ forms. Self-employed taxes have more complications.
Sole proprietors and independent business owners also have to pay their own self-employment taxes. Since you’re not on anyone’s payroll, you’ll pay the self-employment tax so that you’re still making annual contributions to the Social Security and Medicare tax funds.
Both Sole Proprietors and Independent Business Owners Are Self-Employed
Whether take the default route and operate as a sole proprietor or decide to turn your independent business into an LLC or S-Corp, you enjoy several benefits. Each business structure still falls into the self-employed entrepreneurship category.
Self-employed business ownership allows for all sorts of freedom and flexibility that working as an employee for someone else does not.
As a self-employed business owner, you get to make all sorts of decisions:
- Where you work
- If you work full-time or part-time
- How much you charge for products or services
- Whether you work with local businesses or global clients
- How you acquire new customers
- How you market yourself
- What insurance company you choose
- Your business development strategy
The drawbacks of being self-employed include:
- Not receiving paid time off
- Having to pre-pay taxes throughout the year
- Having to pay self-employment taxes
- Paying for your own health insurance and other insurance premiums
Independent business owners and sole proprietors can work in any field. From social media influencers to owner-operator truck drivers, there are endless examples of independent business owners and sole proprietors.
If you own and operate your business by yourself, the default position is that you’re a sole proprietor until you declare yourself to be something else.
So when it’s time to decide what type of business model you want to adopt, weigh your options carefully.
If you want to have a successful business, you’ll need to protect your interests every step of the way.