Going west has a lot to offer many starting a sole proprietorship business. Arizona is one western state that has both desert beauty and a thriving economy. It’s not hard to start a business as a sole proprietorship there either as you don’t have to file any state documents to do it.
However, there are other documents you must file to do business in the land of the Wild West so we’ve put together a guide on setting up a sole proprietorship in Arizona.
What is a sole proprietorship?
A sole proprietorship is an unincorporated business structure with a single owner. For tax and legal purposes, the business and the owner are considered the same entity. This is the simplest version of a business that one can form, and many people who freelance or sell goods are operating as a sole proprietor without realizing it. Because there is no separation between the business and the owner, the owner is personally responsible for all debts and litigation that the business is named in.
Who is a sole proprietorship best for?
By definition, a sole proprietorship is a business with a single owner. Anyone looking to form a partnership or have multiple owners should choose a different structure. A sole proprietorship will be a good fit for someone looking to maintain total ownership of their business who is willing to take on the liability associated.
Because a sole proprietorship is simple to start and requires no fees or paperwork, it can be a good option for small business owners who want to get a business up and running quickly. It can also offer a good test case for a business idea without any upfront requirements.
It can be more difficult to get funding and credit in a sole proprietorship, so if investments are required, having capital at the start can make this structure easier.
How to set up a sole proprietorship in Arizona
1. Choose your business name
Arizona law allows you to operate the 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 search the Arizona Secretary of State’s website to see if the name you chose is taken or if something similar exists.
In Arizona, 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
You are not legally required to file a trade name or mark in Arizona as a sole proprietor but it is an accepted business practice to file one with the Secretary of State’s Office. It creates a separate legal entity. Once you have found the name you want, you must send an application with a check or money order to:
Secretary of State
Business Services – Trade Names and Marks
1700 W. Washington, 7th Floor
Phoenix, AZ 85007
Once registered the trade name or mark becomes searchable through the Registered Name Information Search tool. The cost is $10 for standard DBA filing and $25 for expedite service. It typically takes up to three weeks to get a name registered.
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 Arizona 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.
Arizona doesn’t require any state licenses or permits, other than the TPT license, to run a business. However, cities and counties do have their own laws about permitting. You will need to check where you will be basing your business to know if a permit or license is required.
Some professions require special permitting and licensing. Food service requires food service certifications. Hairstylists and contractors often are required to have a state professional license. You will need to check to see if your industry requires special certifications to work in Arizona.
There are city zoning rules for home-based businesses too. Some Arizona cities allow one employee outside the home to come work for you but the City of Phoenix doesn’t allow anyone living outside the home to work for a home-based business.
Other cities, like Mesa and Tucson, forbid anyone from selling goods at their home. Additional zoning rules apply to other home-based businesses like child care centers, salons, and mechanic shops.
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 entity 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?
Anyone doing business as a freelancer can technically be considered a sole proprietor of their own business. They will pay taxes individually and usually operate under their own name, assuming liability associated with their work. However, there are a number of ways the two can differ.
A sole proprietor is able to hire employees and is responsible for employment taxes, while a freelancer usually cannot do this without filing paperwork and effectively becoming a sole proprietor. Freelancers also do not have to adhere to the same local regulations that a business might and cannot purchase the same types of insurance. A freelancer is considered somebody who has a relationship with external clients, while a sole proprietorship operates as a small business.
In contrast, an LLC is another possible business structure for small businesses. An LLC, or limited liability company, must file articles of organization and register with their state. This also protects the owner (or owners, as an LLC can have multiple) from personal liability, and the business is treated separately for tax purposes. Because of this separation, LLCs are often given larger lines of credit or more likely to attract future investments in times of growth.
What are the advantages of a sole proprietorship?
Fast and inexpensive startup
Unlike another form of business, a sole proprietorship does not have to register with the state or pay the associated fees. If a fictitious name is being used, there may be a registration process for the trade name, but it is optional. This lack of paperwork and cost means that you can start a sole proprietorship almost immediately and without bureaucracy.
In a sole proprietorship, all profits and losses for the business are included in the owner’s individual tax returns. This leaves the owner responsible for state, local, and federal taxes that include their business, but they are not subject to corporate tax rates or specific business taxes. Additionally, being self-employed offers tax credits and benefits to the owner.
Complete control over your business
The sole proprietor of a business has complete control and is responsible for all decision-making within the business. With no partners or shareholders, you are free to run your business as you choose and take risks without implicating others.
What are the cons of a sole proprietorship?
Because the owner and the business are the same in a sole proprietorship, it can leave the owner vulnerable in multiple ways. Any business debts that the business owes are also considered a personal debt, and any lawsuits against the business also implicate the owner. If these result in collections or seizures, the owner’s personal property can be taken in order to meet the obligations of the business.
Difficulty with funding
If a sole proprietor wants to raise capital, they may have fewer options to do so. Without stock in the business to sell, investors are less likely to get involved. Banks may also be less inclined to offer credit because the owner will be responsible for the business loans in the end.
Risks of hiring employees
As long as they have a valid Employer Identification Number, a sole proprietor is able to hire employees as needed. However, if any legal issues arise related to an employee, it could put a strain on the owner as their personal assets are on the line for lawsuits and other costs.
How are sole proprietors taxed in Arizona?
Income tax payments
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 owner then pays income tax on all of the income listed on their personal income tax return, including income from business activity at the applicable rate for the year.
Arizona has different types of licensing and taxes that business owners must pay, which includes sole proprietorships. Businesses must pay for a transaction privilege tax (TPT) license yearly to continue to do business.
This is collected through the Arizona Department of Revenue and renewals must be paid electronically no later than Jan. 1 by anyone doing more than $500 in business a year. The TPT license is good for one year from Jan. 1 through Dec. 31.
The state has penalties for those not filing, including paying 50% of the city renewal fee.
Operating without a TPT license is a class 3 misdemeanor.
Arizona’s income tax rates are some of the lowest in the nation. They are separated into four brackets of 2.59%, 3.34%, 4.17%, and 4.5%. The brackets a person falls into and what they pay depend on taxable income, their residency in the state, and their tax filing status.
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.
Arizona enforces the federal 15.3% self employment tax that is reportable. This tax may apply to sole proprietors, but generally applies to LLC members who take profits from the business in lieu of a salary. Business expenses can be deducted from income in determining how much tax you owe.
You will need to pay state sales tax on anything you sell. Arizona doesn’t impose a sales tax on items deemed necessities, like food or medicine.
The House of Representatives has a bill that allows fewer restrictions from local authorities on home-based businesses but currently, it is up to each city and county to determine if a business can be run out of a home. It depends on the business, zoning, and how it would affect neighbors.
It is not legally required that you register a trade name but most advise it to establish a brand, do marketing and begin a path toward a small business.
The Secretary of State website lists all the various fees and taxes that may apply to your industry and your sole proprietor business.
Arizona recognizes that a business started by a husband and wife is one entity and is a sole proprietorship.
You will need an EIN in Arizona if you plan to hire employees.
The cost of a business license depends on the city or country where the business is based. For instance, Surprise, AZ, charges $168 for an initial business license.
Arizona has always been considered a good state for starting a business. It has low taxes and lots of opportunities.