With a thriving community of small businesses, many people are eager to get their own off the ground in Virginia. If you are looking to form the simplest and fastest type of a business, a sole proprietorship is the choice of many people across the state.
Though a sole proprietorship lacks some of the protections and nuances of other structures, it is often a good fit for small businesses and has benefits of its own.
If you are considering a sole proprietorship, we’ve compiled a guide for Virginians to help you prepare for the next steps.
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 Virginia
1. Choose your business name
Virginia 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 Virginia Corporation Commission’s website to see if the name you chose is taken or if something similar exists.
In Virginia, 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
- Include anything that implies it is a different type of business entity
- Imply it is or will be conducting business as certain entities like a bank or railroad unless it is engaged in that business
2. File a trade name or fictitious name
When your sole proprietorship is formed, it will operate under the legal name of the owner.
However, you can choose to use an assumed name to do business as long as you properly report this to the government. In Virginia, this can be done by registering an assumed name certificate in the county where you will be doing business. The form and filing fee vary by county, but the state does require an assumed name certificate to be filled out.
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 Virginia 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.
Virginia does not require a standard business license for all businesses, though certain agencies will issue licenses and permits for those in certain industries and occupations.
Additionally, many local governments will issue licenses and have their own requirements. For example, the City of Virginia Beach, the City of Norfolk, the City of Richmond, and Fairfax County are all large areas in Virginia that do require general business licenses. The state’s official website recommends this resource to help determine what licenses you may need.
Most businesses will need to obtain a sales tax certificate, also known as a seller’s permit if they are engaged in selling or leasing tangible personal property in Virginia. There is no charge to apply for this certificate, which can be obtained through an online application.
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 Virginia 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 Virginia?
Simple way to start a business
Virginia 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 Virginia?
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. In Virginia, income tax rates increase with income and can range from 2% to 5.75%.
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. The average effective property tax rate in Virginia is relatively low at 0.80%. All Virginia businesses are also responsible for collecting a 5.3% sales and use tax for most goods and services.
When a sole proprietorship has one or more employees, they become responsible for a range of employment taxes paid to the state and the IRS. This includes withholding taxes and unemployment insurance taxes that are calculated based on the employee’s pay rate.
EINs, or employee identification numbers, are issued to businesses by the IRS for tax filing purposes. Sole proprietorships do not need an EIN unless they have employees, as taxes will go through their personal Social Security Number.
The same rules apply for the state-level Virginia Tax ID Number. Some sole proprietorships will decide to apply for an EIN to help with processes like obtaining a bank account.
If you want to reserve a name before you move forward with filing for an assumed name, you can do so through the Virginia Corporation Commission by filing a reservation and paying a $10 filing fee. This will reserve your name for 120 days, at which point you must renew it or register the name formally in order to maintain the rights to use it.
Any business in Virginia, including sole proprietorships, can register for a sales tax certificate or a seller’s permit. A business that sells or leases tangible and digital goods or most services will need this permit in order to collect and remit tax. Examples of exemptions to the sales tax may include protective clothing, assistive medical devices, textbooks, and software.
Forming a sole proprietorship in Virginia requires a one-time $20 registration fee. The only other requirement is to apply for a sales tax certificate, which does not cost anything unless you choose to expedite the process.
However, many sole proprietorships operate under an assumed business name and apply for this through the relevant county. Each county can set a filing fee for this process.
A sole proprietor will pay taxes on all business income through their personal income taxes under the relevant tax rate. They are not responsible for other business taxes, though property taxes and sales tax do apply.
If a sole proprietorship has employees, they will also have to pay withholding tax and unemployment insurance tax.
No, a sole proprietorship does not have to file an annual report in Virginia. Only corporations have to file these reports to verify that all information is up to date as a condition of continuing to conduct business in the state. There is no required reporting for sole proprietorships.