In the start-up phase of your crafts business, an important step is the selection of a business entity. Every choice and necessary business action you take will vary based upon the type of business entity you select.
Most brand new craft businesses start out as sole proprietorships. And there’s a good reason why – this type of business entity is the easiest and cheapest type of business entity to start and maintain.
Well, it doesn't get much easier than this – once you make your first sale or incur your first business expense you are officially in business as a sole proprietorship. Like the name implies, a sole proprietorship has one and only one owner – you. So you can't own a sole proprietorship with anyone else like your spouse or a friend. While there can be only one owner, you can hire as many employees as you need.
Most sole proprietorships operate using the owner's social security number. This is fine unless you hire even one employee. Then you'll have to get an Employer Identification Number (EIN) because you can't use your social security number to issue W-2s. You apply for an EIN using Internal Revenue Service Form SS-4.
Your social security number is ok to use if you need to issue 1099Ms to contractor workers.
There are no expensive filings with your secretary of state like with a corporation or flow through. Just keep in mind that regardless of your type of business entity you'll probably have to get a business license from your city, county or both.
As a sole proprietor, you'll report the net income of your business on your Form 1040, so tax preparation hassle and expense is reduced as well. You'll initially record all your business income and expenses on the Schedule C and the bottom line, net income or loss is part of adjusted gross income shown on page one of the Form 1040.
This might seem a little confusing so I'll give you an example that may be familiar. Have you ever sold stocks or bonds? The cost and sales proceed of the stock or bond initially is reported on Schedule D, then you add them all up and put the grand total on the page one of the Form 1040.
The Schedule C is just like that. It's just another part of your tax return that contains detailed info with the bottom line flowing through to the 1040.
The Important Part - How Sole Proprietors Get Paid
The sole proprietor is not an employee of the business so you won't be getting a traditional type of paycheck. A sole proprietor receives a draw check. Ok, what's a draw? You want to be paid $500? Write yourself a check for $500 – there's your draw. It's that easy!
You don't withhold employment taxes from the draw check. Of course, you will eventually have to pay taxes. Self-employment tax and income tax on the sole proprietorship are paid with estimated tax deposits periodically through the year or on your Form 1040 when filed.
Sole Proprietorship DisadvantageThe major disadvantage to being a sole proprietorship is the liability issue. A sole proprietor without exception is responsible for all debts and actions taken against the business. However, unless you are selling an edible or potentially dangerous product the chance that one of your customers will sue you is probably remote. To cover that eventuality I recommend that all businesses, not just the sole proprietorship, acquire business liability insurance.
Due to the ease of setup and operation, many arts / crafts businesses start out as sole proprietorships and never feel the need to convert the business to another type of entity.