How to Start a Sole Proprietorship in California
Starting a sole proprietorship in California is a straightforward process that can be done without much hassle. This type of business structure is ideal for freelancers and small businesses offering clients services. This guide will walk you through the steps to start your sole proprietorship in California. It will provide valuable information about the benefits and drawbacks of this business structure and offer useful resources to help you along the way.
What is a sole proprietorship?
A sole proprietorship is a simple form of business entity. It is operated by a single owner responsible for the business’s finances and debts. They are easy to set up and, for this reason, are popular amongst solo entrepreneurs and startups. Unlike business structures like Limited Liability Companies (LLCs) or corporations, there is no legal separation between the business and the owner.
While a sole proprietorship offers simplicity and flexibility, it has some drawbacks. The main disadvantage is the lack of asset protection. As a sole proprietor, your personal assets, like your car, home, and savings, are at risk if your business runs up debts or has any legal obligations.
A step-by-step guide to starting your California sole proprietorship
Choose a business name
If you decide to operate your business under a name different from your legal name, you must file a Fictitious Business Name Statement, also referred to as a DBA (Doing Business As). Your DBA must be filed with the county recorder’s office where your business is located.
Filing a DBA allows you to use an assumed name for your business, making it more professional and trustworthy in the eyes of your clients.
Here are the steps to filing your DBA:
- Choose a business name: When choosing a name, brainstorm catchy options that communicate what your company does. An easy-to-remember and descriptive name can be a valuable marketing asset that attracts new customers.
- Check availability: Once you have chosen your name, you have to confirm your proposed name is not already taken by another business.
There are two key resources to check:
- The California Secretary of State has a search page that allows you to search for business entities already registered in California.
- The US Patent and Trademark Office allows you to search the national trademark database. Review trademarks to ensure your name does not infringe on any intellectual property.
- Check online availability: Verify your business name is available as a .com domain for your website. Check that related social media handles are free to claim as well. Securing matching domains and usernames creates continuity between your business name and online presence. This helps build your brand and makes it easy to discover online.
- Register the business name: Complete the necessary forms the county clerk’s office provides and pay the filing fee. You can find county contact details here. This will officially register your DBA. After filing your DBA, you must publish a statement in a county newspaper for four consecutive weeks.
Obtain an (Employer Identification Number) EIN
Sole proprietors without employees don’t need to register for a federal tax ID number. They can use their Social Security Number (SSN) for tax purposes.
However, we recommend obtaining an EIN from the Internal Revenue Service (IRS) for several reasons:
- Opens up business banking opportunities: An EIN is often required to open a business bank account. This can help separate personal and business finances.
- Helps establish business credit: With an EIN, you can apply for business credit cards and loans separate from your credit. This can help you build credit for your business, which may be useful for future financial opportunities.
- Eases hiring process: If you plan on hiring employees in the future, you must have an EIN. It must report taxes and other documents to the IRS and set up payroll because it helps distinguish employees from employers.
- Enhances business privacy: An EIN can also replace your social security number in business paperwork, protecting you from identity theft and adding an extra layer of privacy.
- Prepares for business growth: Even though a sole proprietorship does not legally require an EIN, having one can simplify the transition if you decide to incorporate or restructure your business.
You can apply for your EIN here.
Obtain California business licenses, permits, and zoning clearances
Depending on your business type, you may need to obtain specific licenses, permits, and zoning clearances.
- California does not require a general business license. You can use the CalGold database the California Governor’s Office of Business and Economic Development provides to determine which licenses, permits, or zoning clearances you need.
- CalGold allows you to search for the required licenses and permits based on your business, county, and city.
- It provides comprehensive information about the permits and licenses that apply to your specific business.
- In addition to state and local requirements, certain industries or professions may have specific licensing requirements from state agencies such as the California Department of Consumer Affairs.
- Major cities in the state of California, Los Angeles, San Diego, and San Jose, to name a few, may have specific local licenses and permits that you must apply for.
Register for taxes
As a sole proprietor, you file your company taxes in the same way as you file your personal tax return. When you file your personal income form, Form 1040, each year, you will include a Schedule C, which lists your business’s income and profits or losses.
As a self-employed sole proprietor, you owe self-employment tax contributions for Social Security and Medicare, which you can calculate and report using Schedule SE.
Unlike employees who normally have these taxes withheld from their paychecks, sole proprietors are entirely responsible for paying both portions of these taxes.
Additional state and local taxes
- In California, sole proprietors are subject to state income tax. You must report your business income on your personal income tax return (Form 540).
- If your business sells tangible goods, you may need to register for a seller’s permit and collect sales tax from customers. Visit the California Department of Tax and Fee Administration website for more information on sales and use tax requirements.
- Depending on your business activities, you might be subject to additional taxes at the state or local level. Research and understand any specific tax obligations related to your industry or location.
After you’ve secured your EIN, registered for federal taxes, and received the necessary licenses, you’ve completed the essential steps to establish your sole proprietorship.
We suggest a few more tasks to help your small business stay aligned with rules and well-organized.
Open business bank accounts
Drawing a line between your personal and business finances is crucial for maintaining accurate financial records and preserving your assets. Consider setting up the following:
- Business bank account: Establishing a separate account can simplify the tracking of income and costs, simplify tax filing, and lend credibility to your operation.
- Business credit card: Having a business credit card not only helps segregate personal and business expenses but also aids in monitoring business-related costs and building your business’s credit, which can prove beneficial in the future.
Get liability insurance
As a sole proprietor, you bear the full brunt of any business liabilities, making insurance a crucial aspect of your business plan. This can protect you from unforeseen claims or incidents. We recommend looking into the following:
- General business liability insurance: This policy covers accusations of property damage, bodily harm, or personal injury linked to your business activities.
- Professional liability insurance: If you offer services, this insurance is critical as it shields you from claims of supposed negligence, mistakes, or oversights in your service provision.
Maintain business records
Careful recordkeeping helps maximize tax deductions and organize your sole proprietorship’s finances. Be sure to track:
Using bookkeeping software, spreadsheets, or an organized system makes staying on top of documentation easier for tax filing and general financial health.
Sole proprietorship vs. LLC
For some businesses, forming an LLC may better serve long-term goals than a sole proprietorship. LLCs offer advantages like:
- Liability protection: Your personal and business assets are legally distinct with an LLC structure. Your business is a legal entity that files taxes separately from the business owner.
- Credibility: The formal LLC designation can boost your professional image with customers.
- Growth potential: LLCs are well-suited if you aim to expand your current operations eventually.
- Tax flexibility: LLCs permit you to select how your business income is taxed.
However, LLCs also come with tradeoffs to weigh:
- Complexity: LLCs require drafting an operating agreement and annual reporting obligations. Sole proprietorships involve less paperwork.
- Cost: Forming and maintaining an LLC has higher upfront fees and ongoing costs.
Useful resources to help start your sole proprietorship in California
- California Secretary of State
- US Patent and Trademark Office
- California County contact details
- EIN application
- Personal tax form 1040
- Schedule C
- Schedule SE
- California personal income tax return (Form 540)
- California Department of Tax and Fee Administration website
- California Governor’s Office of Business and Economic Development
- California Department of Consumer Affairs
Can I operate my sole proprietorship under a trade name?
Yes, you can operate your sole proprietorship under a different name by filing a Fictitious Business Name Statement with the county recorder’s office where your business is located.
Do I need a business license to operate as a sole proprietor in California?
While the state of California does not require a general business license, you may need to obtain specific licenses or permits depending on your business activities.
Can I hire employees as a sole proprietor in California?
Yes, sole proprietors in California can hire employees.
Can I convert my sole proprietorship into an LLC?
Yes, converting your sole proprietorship into an LLC is possible if you establish a more formal business structure with personal liability protection.
Do I need liability insurance as a sole proprietor?
While liability insurance is not mandatory for sole proprietors in California, it is highly recommended.
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