To establish a sole proprietorship in Tennessee, you do not need to file any legal documents with the state. This simple and inexpensive business structure is the most common structure in the United States because of the ease of the process.
However, there are still steps that must be taken to ensure that your business meets all the requirements in Tennessee for operating a business, including a sole proprietorship. This simple guide will help you determine if a sole proprietorship is a right choice for your business and determine the next steps you need to take before starting out.
What is a sole proprietorship?
A sole proprietorship is a business entity that refers to an unincorporated business with a single owner. This is the simplest possible structure to set up a business. 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 as a part of your personal income. 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 Tennessee
1. Choose your business name
Tennessee law allows you to operate a sole proprietorship under a name other than your own name. While you can use your name, most people choose a specific business name. If you want to do this, you should first search the Tennessee Secretary of State’s website to see if the name you chose is taken or if something similar exists.
In Tennessee, 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
- Falsely imply your business is associated with fraternal, veterans, religious, charitable, or professional organization
- Imply the company is organized for an unlawful purpose
2. File a trade name or fictitious name
In order to set up a fictitious name in Tennessee, a sole proprietorship must first file a Business Tax License Application with the county clerk’s office where they will be operating or conducting business.
If you will be working in multiple counties, this process must be repeated in each. No state agency requires you to file a fictitious business name, though it can be done through the Tennessee One Stop Business Resource.
County requirements may differ throughout the state. Some counties will have a filing fee and others may require a paper registration in addition to digital ones.
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 Tennessee Department of Business and Professional Regulation (DBPR), though some areas like health care are licensed by independent areas.
Tennessee does not require a general business license, though anyone engaged in business in the state who intends to sell or lease taxable goods and services will need to obtain a seller’s permit. Also called a sales tax certificate, this registers a business for taxes that must be paid, though this does not apply to a sole proprietorship. However, it also gives a business the right to collect sales tax and pay them back to the state regularly. A sales tax certificate can be obtained through the Department of Revenue.
You should also explore local regulations like building permits and zoning clearances where appropriate. Many cities in Tennessee require a local version of a seller’s permit and may require other licenses and permits that the state does not require. For example, the City of Nashville requires pawnbrokers to have a permit to operate there.
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 Tennessee 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, 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 Tennessee?
Simple way to start a business
Tennessee 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 a sole proprietorship?
No personal asset protection
In a sole proprietorship, you are considered the same entity as your business, which means you are liable for any financial aspects of your business. If the business has a financial obligation that can’t be met, your personal money 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 accounts and lines of credit as an LLC or a corporation. Government grants and funds awarded to small businesses are usually not available for sole proprietorships. 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 Tennessee?
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 owners make tax payments on all of the income listed on their personal return, including income from business activity at the applicable rate for the year.
Tennessee is a state that does not impose any income tax on wages, meaning it has a 0% tax rate that is applied to all business income for sole proprietors. In order to gain revenue, the state instead has a flat 1 to 2% tax rate that applies to any income earned from interest and dividends. Because Tennessee does implement a business tax, sole proprietorships may have a tax advantage by not needing to claim income tax.
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. Tennessee has some of the lowest property tax rates in the United States, with the average effective rate coming in at 0.64% and average payments being about half the national average.
With no income tax, employers do not need to pay withholding taxes, but they are responsible for State Unemployment Tax Act (SUTA) taxes. New employers pay a rate of 2.7%, with a range of 0.01% to 10.0% across employers.
About 60% of Tennessee’s revenue comes from a sales and use tax. The sales tax is composed of both a state tax, at about 7%, and a local rate that varies by county and/or city.
To operate under a fictitious name or doing business as in Tennessee, there is no state-wide requirement for sole proprietorships. However, each county clerk will require you to file a Business Tax License Application in order to use the fictitious name. Each office may have a different filing fee and renewal schedule.
Tennessee has both state and local sales tax that is collected by businesses, including sole proprietorships. Any business that sells (or leases) tangible personal property and certain services must obtain a license to collect this tax, as well as certain digital goods. The business will collect this tax and pay it according to a set schedule, including sole proprietorships.
The only state-wide license that every business requires in Tennessee is a seller’s permit in order to remit sales tax. However, particular industries and professions may need to obtain licensure and permits through the state in order to operate. Additionally, each city or county may require licenses to operate in their area on top of state requirements.
No, while these are often confused, they are not the same. A sole proprietorship is a business structure that has tax and legal liability implications and usually operates under the legal name of the owner. A DBA is an assumed name that the business uses for its operations. Sole proprietorships can use a DBA in Tennessee.
Many business structures require a registered agent to be determined, who will act as the formal business and legal contact on behalf of a business. Because sole proprietorships are the same legal entity as their owner, they do not need to designate a registered agent and will instead be treated as this primary contact.