During the process of starting a business, many people identify sole proprietorships as the structure they think will work best for them. These businesses are simple and inexpensive to create, making them the most popular structure not just in Connecticut, but all of the United States.
However, a sole proprietorship must still follow certain rules and regulations like all businesses and have some unique challenges of their own. Before deciding if this structure is right for you, it is important to understand all aspects of a sole proprietorship.
What is a sole proprietorship?
A sole proprietorship is an unincorporated business entity that has a single owner. This is the simplest possible structure to set up as a small business owner. 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 on your personal income tax return. Your tax payments are paid personally. 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 Connecticut
1. Choose your business name
Connecticut law allows you to operate a sole proprietorship under a name other than your own name, also known as an assumed name or trade name.
In Connecticut, a startup 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
- Use a business entity suffix, like LLC, where it is not accurate
2. File a trade name or fictitious name
When your business is operating under a name other than the one on your tax returns, you will need to file for a trade name certificate. This is done through the town clerk in the town where you do business, rather than at the state level. You can reference the town clerks directory for Connecticut to find the relevant office or offices for your business. In each town, the filing fee for a trade name is $5.
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 Connecticut Department of Business and Professional Regulation (DBPR), though some areas like health care are licensed by independent areas.
Not every business in Connecticut will require a license as there is no general requirement throughout the state for sole proprietorships. However, most businesses will need a license to collect and remit sales tax, and others may have industry-specific licensing requirements.
In Connecticut, a sales tax permit is required for any business with a physical presence in the state that sells, rents, or leases goods or provides a taxable service. These permits can be obtained through the Connecticut Taxpayer Services Center or by mailing in these forms. There is a $100 fee associated with this, and it can take up to 15 business days to receive the formal license. In the meantime, a temporary one is provided so that sales can begin immediately. Sales tax permits must be renewed every 2 years.
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, you officially have your own business! 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 Connecticut 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 the 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 or other independent contractors, 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 prop.
What are the advantages of a sole proprietorship in Connecticut?
Simple way to start a business
Connecticut 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 partners, 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 the sole proprietorship, you are considered the same entity as your business, which means you are liable for any financial aspects of your business. The business’s debts become your financial obligation. Your personal assets 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 loans and lines of credit as an LLC or a corporation. Government grants and funds awarded to small businesses are usually not available for this form of business. 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 business debts.
How are sole proprietors taxed in Connecticut?
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.
Connecticut has a progressive tax rate, with seven income brackets ranging from 3% to 6.99%. Based on the amount of income an individual or couple brings in through their sole proprietorships, the relevant rate will be applied to these earnings.
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.
Connecticut also has one of the highest property tax rates in the country, with an average effective property tax rate of 2.14%. Only two states are higher.
If a sole proprietorship has any employees, the owner is responsible for filing the proper withholdings through the state and taxing the employee to remit to the state.
Almost any business with a physical presence in Connecticut must obtain a sales tax permit. This includes out-of-state online businesses who sell over $250,000 or 200 transactions to Connecticut residents and have regular systematic solicitation of sales in Connecticut. In the state, most goods are subject to a sales tax, while most services are not.
In order to operate under a name other than your own legal name, a trade name must be filed with the town clerk where you do business. The fee to do this is $5. However, if you have multiple locations or are working in multiple towns, you will need to file with each clerk, meaning you may pay this $5 fee multiple times.
An employee identification number, or EIN, is used by the IRS for tax purposes. Sole proprietorships file their taxes on their personal income taxes and thus do not require a business tax ID number. However, if a sole proprietorship has one or more employees, an EIN will be necessary in order to file federal taxes related to their employment.
Connecticut issues tax IDs separate from the EIN issued by the IRS. These IDs are used for businesses to file their taxes. Sole proprietorships are not required to obtain a tax ID in Connecticut as they claim business income and expenses on their personal returns. However, if the sole proprietorship has employees, they will need a tax ID in order to properly withhold and file employment taxes.
While Connecticut has a general business license requirement, it does not apply to sole proprietorships. However, sole proprietorships will still need to obtain a sales tax permit as well as any professional licensure and industry licensure required. They may also need to obtain a business license in the town or municipality where they conduct business.
Sole proprietorships are able to have employees. They must pay all applicable taxes and properly withhold and remit taxes on behalf of the employee to both the state of Connecticut as well as the federal government through the IRS. Having employees may also mean the business needs to obtain additional insurance.
The fee to file for a sales tax permit in Connecticut is $100 and the license must be renewed every 2 years. However, a business must obtain this permit individually for every site or location it has in the state, so the cost may be more if your business has multiple locations.