Are you ready to turn your passion into a business? Well, you came to the right place. If you are looking to create a Michigan-based business, you can start a sole proprietorship. The requirements to start a sole proprietorship vary from state to state, but this article will focus on how to start a sole proprietorship in the state of Michigan.
Many large companies start small, and if you are still working full-time and want to start a side hustle, a sole prop business structure might be your best bet. Fortunately, we can help you get started by providing the information you need to start your small business.
What is a sole proprietorship?
The simplest and most common structure used to start a business in the United States is called a sole proprietorship. These businesses are formed when a single owner forms an unincorporated business and runs that business as an individual.
A sole proprietorship is not a legal entity. This means the owner is entitled to all profits raised through the business and files them as part of their individual taxes. However, this also means that any business debts and losses are attributed to the individual, as well as them being implicated in any lawsuits brought against the business.
Who is a sole proprietorship best for?
If you are planning to start a business along with a partner or multiple partners, a sole proprietorship is not an option. The structure will be a good fit only if you plan to operate your business entirely independently, or with employees who report to you as the owner.
Many people choose a sole proprietorship if they need to quickly start their business or want to avoid filing fees and paperwork. In fact, if you are running the business in your own name, there is no paperwork to fill out at all to register your business. This allows the business to get up and running quickly with no friction.
A sole proprietorship comes with financial liability and it may be more difficult to secure a line of credit or investments.
How to set up a sole proprietorship in Michigan
1. Choose your business name
Michigan law allows you to operate a 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 Michigan Department of State’s website to see if the name you chose is taken or if something similar exists.
In Michigan, 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
Although most sole proprietors only use their given name to do business, it is always ideal to file for a trade name or Doing Business As name (DBA). It will enable you to assume a name for your business, which many small business owners prefer. It’s more trustworthy than doing business with someone’s personal name.
Sole proprietors with a DBA can also open a business bank account using the trade name, allowing you to separate your personal and business finances. Although you will file taxes under your personal social security number, you can still benefit from segregating your personal and business income.
You can go to the County Clerk’s Office to file for your DBA, but before doing so, it is better to make sure that the fictitious name is available for you to use by checking the business entity database from the Michigan Department of Licensing and Regulatory Affairs or LARA.
The process usually takes one day when you walk-in at your local County Clerk’s office, as long as you have all the requirements prepared, and the filing fee is around $25 to $50, depending on your business structure.
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 Michigan 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.
Not every business in Michigan is required to be licensed by the state, but there are specific businesses that need licenses to operate. If you are not sure about which licenses you need to obtain, you can visit the Michigan State License Search tool and use the keywords that describe your business to find out.
If you are a professional, you might need to obtain certain licenses depending on your profession. You can learn more about the requirements by visiting the Bureau of Professional Licensing Website.
If your business has something to do with environmental regulations, you will need to consult the DEQ checklist to find out if your business needs an environmental permit.
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 own business 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?
An LLC, or limited liability company, is another common structure used for small businesses in the United States. While an LLC can have a single owner, it can also be owned by multiple people working together. The key differentiator for an LLC is that it offers protection of the owner’s personal assets. As a legally separate entity, an LLC is liable for debts and legal obligations, but the owner cannot be personally liable for these items. If the business fails, the owner could file for business bankruptcy without owing business creditors their own money.
If you’re wondering about the difference between freelancing and setting up a sole prop, you’d set up a sole prop if you plan to hire other writers to work with you. A freelancer can’t hire people, but a sole prop can.
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What are the advantages of a sole proprietorship?
Simplified tax preparation
For the owner of a sole proprietorship, tax preparation is not much more complicated than it is for any other private citizen. In preparing personal taxes, the owner will include all profits and losses related to the business, which is calculated as a part of their income or expenses. This also means the tax rate stays at their individual rate as opposed to higher business and corporate tax rates.
Less paperwork and fees
To register most business structures, the state requires you to file your business name for inclusions on their directory and pay a fee. A sole proprietorship does not have to do this. There will be some paperwork and fees involved if you require licenses or permits, or you plan to operate under a fictitious name.
The sole proprietor of a business is responsible for everything, both good and bad. While personal liability is placed on that owner, they also enjoy complete control of their business. Any business decisions will be solely their responsibility, without worrying about pleasing shareholders or disagreements with a partner.
What are the cons of a sole proprietorship?
No asset separation
In a sole proprietorship, there is no legal separation between the assets of an owner and the business. While this makes things like taxes simple, it also means there is no delineation between the liabilities of an owner and their business. This means that if the business is not successful, any debts owed will fall to the sole proprietor, and if they cannot pay, it is their personal property that will be seized. In the case of a lawsuit where money is owed, the same is true.
Single point of failure
When only one person is responsible for an entire business, it means that they are the single point of failure. If a sole proprietor passes away, becomes incapacitated, or is incarcerated, the business is usually not able to survive. While a corporation can be taken over as a legally separate entity, a sole proprietorship must be run by the owner.
Less availability of funding
Many banks and investors do not like to offer funds to sole proprietors, as they cannot gain shares of the company or be sure that debts will be repaid. Many government grants and business loans also exclude sole proprietorship.
How are sole proprietors taxed in Michigan?
Income tax returns
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 personal income tax on all of the income listed on their personal return, including income from business activity at the applicable rate for the year. The sole proprietorship can opt to pay estimated taxes each quarter as well.
Sole props that hire employees will need to get an EIN or Employer Identification Number. But since most sole props do not hire permanent employees, you can hire independent contractors to work for you and only file a 1099 form.
In Michigan, the deadline for filing taxes of a sole proprietorship is the same for filing personal taxes, which is the 15th of April every year.
For more information about taxes and help with determining taxes, such as withholding tax, miscellaneous tax, and motor fuel tax, you can visit the Business Tax Section on the Michigan Department of Treasury Website.
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.
Since 2007, the state of Michigan requires businesses to pay the Michigan Business Tax, which serves as a tax on business income at a 4.95% rate. Additionally, you will need to pay gross receipt taxes at a 0.08% rate.
Depending on the nature of your business, you might also need to register and pay taxes that are specific to your industry. By visiting the Michigan Department of Treasury Website, you can determine the industry-specific taxes that you might need to pay.
There are a few business tax types in Michigan that you may need to register and pay depending on your business. Some of the taxes include corporate income tax, flow-through entity tax, IFTA tax, motor fuel tax, and more. There are also special tax situations that some businesses need to pay, such as nonprofit information, Native American tax, and tax clearances.
There are companies that offer help in forming a business. Some people simply don’t have the time to gather the requirements and file the licenses themselves, which is why many people and companies are offering services that can help you start your sole proprietorship hassle-free. These companies will research the licenses and permits you need on federal, state, and county levels so you don’t have to.
Not all sole proprietorships need to register in Michigan. However, there are some industries that require licenses and permits to legally operate. Make sure you visit the Michigan State Website to determine if your business needs specific licenses to operate or other important steps you need to take to avoid fines.