The decision to start a small business is not to be taken lightly. Any startup requires a great deal of time and investment from the owner. This includes taking the proper steps to establish your business through registration and licensing once you determine the business structure that is right for you.
Because of its quick and inexpensive nature, many people choose to establish a sole proprietorship, but it is important to follow all regulations set by Washington state.
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 Washington
1. Choose your business name
Washington 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 Washington Secretary of State’s website to see if the name you chose is taken or if something similar exists.
In Washington, 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
2. File a trade name or fictitious name
A sole proprietorship can be operated under your legal name with no additional steps necessary. However, if you choose to use another name, you will need to register a trade name through the Washington State Business Licensing Service. To do so, you will fill out a Business License Application and pay the $5 filing fee associated.
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 Washington State Department of Revenue, 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.
Washington is a state that requires a business license in order to operate. Almost every business will need to complete a Business License Application, online or by mail, and pay the associated $19 fee. This will register you with the Department of Revenue, Department of Employment Security, and Department of Labor and Industries.
Once registered, you will receive a business license as well as a state Unified Business Identifier Number. This is a nine-digit number that allows you to do business in Washington.
You can then determine if you need any occupational or professional licenses from Washington. These are required for a range of businesses, including barbers, architects, and private investigators.
Each Washington city and county will also establish its own licensing requirements and procedures, with most requiring a separate permit to operate a business. Usually, this process just requires paying a fee. These fees can range from $25 to a few hundred, or be based on your projected gross revenue.
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.
This is different than a Unified Business Identifier Number.
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 Washington 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.
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What are the advantages of a sole proprietorship in Washington?
Simple way to start a business
Washington 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 Washington?
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.
Washington does not have a state income tax, but unlike some other states, it is essentially replaced by a Business and Occupation (B&O) tax. This tax calculates payment owed based on gross income, or the total amount of revenue your business reports each year. One way this differs from a traditional income tax is that it does not change based on if you took a loss that year- only incoming payment is counted.
The B&O tax rate is determined by the industry your business is in. Manufacturing, wholesaling, and retailing each have their own tax rate, while all other businesses are subject to a flat 1.5% rate. There are no deductions for business expenses when filing a B&O tax, though there are large credits.
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. In Washington state, property taxes are applied by each county, so rates can vary heavily.
Washington also implements a sales tax and a use tax. The base rate for state sales tax is 6.5%, but each county or city can also charge a local rate in addition to this. For example, in Issaquah, the total sales tax is 10.1% while in Pomeroy it is only 9.5% in total.
When sales tax is not applied, such as purchasing items from another individual, a use tax can be applied. Most businesses will not encounter this, but it is important to know it can be applied when sales tax is not.
Yes, every business in Washington state must obtain a Unified Business Identifier Number. This is similar to the federal EIN, but works at the state level and everyone must obtain it. This includes independent contractors and sole proprietorships.
Use tax is meant to be applied when sales tax has not. This often occurs during a resale process, like using an online marketplace or selling an item to a friend. It is calculated at the same rate as sales tax and is paid directly to the state.
Use tax should apply to any items purchased in Washington or brought in from another state where sales tax was not applied.
Yes, any business in Washington can hire employees. You must inform both the IRS and the State of Washington before hiring your first employee and obtain the proper insurance and file the correct forms. This can include payroll taxes and withholding allowances and other employment licenses.
Most goods and services in Washington state will need to have sales tax applied. This includes services such as construction, recreation, digital, and personal services. Food and prescription drugs are examples of things exempt for the sales tax.
In Washington, every business must obtain a general business license through the Department of Revenue. This includes independent contractors and sole proprietorships. The same will most likely apply at the city or country level, though they can set individual rules around business licensure. Be sure to check with the local offices where you will be operating.