Starting a sole proprietorship business
I was working in an IT company for the past few years. Recently due to COVID, I lost my job. Now, I plan to start a sole proprietorship web development company. Some of my friends have also agreed to work with me. Is the sole proprietorship ideal for an IT company? Is it risky?
There's always some level of risk. And how to form your business is a question with a million different answers depending on the specifics of what you plan on doing (just make sure you have a plan!)
Sole Proprietorship is the easiest type of business to form and the one that holds the greatest level of risk to your personal assets. You are fully liable for the company's debts, as well as legally liable for any wrongdoing the company could be sued for. The most common example of the personal liability is that if the company is sued, you are personally liable for that and any judgement that comes out of it. That could open your personal assets to seizure in order to cover those costs in the most extreme of cases.
Are these friends going to be employees? Or did they want ownership in your company? Because if it's ownership then you can't have a sole proprietorship. You're looking at either a partnership or some form of corporation in that case. These are the ones that are more difficult to form (and usually cost a bit to establish) but add layers of protection between you and the business.
If you're going to have employees, make sure to think about employment taxes. They're complex and devastating to get wrong. Payroll software will be your friend.
Speaking of taxes, the way taxes work for the different business types is something to think about as well. A sole proprietorship will simply be reported on a separate schedule of your personal tax return and net income/losses will flow through to your return. Partnerships pass through their income/losses to the owners at a rate determined by ownership. Corporations have their own tax returns since they are their own legal entities, and the only thing that would impact your own taxes are the dividends and/or salaries you take out of the business as the owner.
So...complicated. You can always start as a sole proprietor to test the waters and see if things will grow and then incorporate later. Just be ready to pivot if needed. And if you do go the proprietor route, register your business name as a DBA (doing business as) in your county. Lets you open bank accounts and such in your business name, which just looks much more professional than using a personal account.
Hi there, I am in my second tax year as IT freelance. There is no reason to risk a traditional SP. Open an LLC. If you are one person you will file with your SSN instead of tax ID. In either case you are not risking your personal assets if you are sued.
The IRS process is easy. Different states do this very differently have have different costs. Your secretary of state's office is your source. Colorado is exceptionally easy peezy and cheap. You will need to open a bank account also. Credit Unions are often small business friendly. I actually opened a free one and got $250 for it.
Personally I wouldn't pay anyone. Everyone is independent. I worked with a startup at the very beginning and everyone was independent. If you pay them they file just like you and you give them a 1099 at the end of the year.
There is a book called the Freelancers Bible that I recommend. It has a lot of information and tips.