Sole Proprietorship in Alabama
Sole means one. And Proprietor means owner. Put them together and you have a Sole Proprietor, or Sole Proprietorship. A Sole Proprietor is the person. A Sole Proprietorship is the business entity.
A Sole Proprietorship in Alabama is an informal structure with one business owner. Often, it is the easiest and simplest form of business structure to create. However, that doesn’t always mean they are the best choice for small business owners.
While Sole Proprietorships have some advantages, there are also disadvantages you should be aware of.
We’ve explained these below, as well as provide step-by-step instructions if you decide to start a Sole Proprietorship in Alabama.
Pro tip: Sole Proprietorships don’t protect your personal assets. On the other hand, if you form an LLC, your personal assets are protected in the event of a lawsuit. Check out Sole Proprietorship vs LLC for more information.
Advantages of a Sole Proprietorship
Ease of setup and maintenance
The primary advantage of a Sole Proprietorship is how easy they are to set up and to maintain.
In fact, there is no form to file in order to “create” one. If you’re doing business by yourself, you’re operating as a Sole Proprietorship.
Think of it this way: once you engage in business activities, with the goal of eventually making money, you are operating as a Sole Proprietorship.
For example, if you want to start a wedding planning business, the moment you begin doing business research, calling potential customers, or building your website, you’re operating as a Sole Proprietorship.
The second advantage of a Sole Proprietorship is taxation. Filing taxes for a Sole Proprietorship business is very similar to how you already file your individual taxes.
Meaning, you already file a personal Form 1040 tax return each year. However, as a Sole Proprietorship you (or your accountant) will include a Schedule C which lists your business profits or losses.
Disadvantages of a Sole Proprietorship
There is one major disadvantage and a few other minor disadvantages of a Sole Proprietorship.
No liability protection
The main disadvantage of a Sole Proprietorship is liability protection: there is none.
If your business is sued, your personal assets (like your home, cars, and bank account) could be used to settle the business’s debts and liabilities.
On the other hand, if you formed an LLC or a Corporation, your personal assets are protected in the event of a lawsuit. Only the business’s assets can be used.
Tip: LLCs offer additional asset protection that Corporations don’t.
Lack of credibility
Even though you can file a DBA name (discussed below), Sole Proprietors are still often seen as being less credible.
On the other hand, if you were to form a legal business entity, like an LLC or Corporation, those are considered more official and reputable.
Converting from a Sole Proprietorship to an LLC
If you start your Alabama business as a Sole Proprietorship, and then later want to convert to an LLC or Corporation, it’s a large headache with many steps involved.
There isn’t a one-step process to convert a Sole Proprietorship to LLC. In fact, there are often multiple steps and multiple filings you must make with various state departments and local governments.
For example, you need to update the state, the IRS, and the bank that your business type has changed. And if your business requires a license or permit to operate, you will need to re-apply for those as the new business. You may also need to redo contracts with your clients and vendors, and update your website and marketing materials.
So if you’re on the fence about which type of Alabama business to choose, and you have the money to spend on an LLC, we recommend starting an LLC in Alabama.
Sole Proprietorship vs LLC
- Quick Read: What is an LLC and what does it do?
A Limited Liability Company (LLC) is a legal entity that offers pass-through taxation and asset protection. If your LLC is sued, your personal assets – like your home, car, and personal bank account – are protected.
An LLC with one owner is called a Single-Member LLC. And the great thing about them is they are taxed just the same as a Sole Proprietorship. Check out LLC taxed as Sole Proprietorship for more details.
To start an LLC in Alabama, you need to file the Certificate of Formation with the Secretary of State and pay a $200 filing fee.
If you want to hire a company to form your LLC, we recommend Northwest Registered Agent.
If you decide you’d rather operate as a Sole Proprietorship, we have the instructions below.
How to start an Alabama Sole Proprietorship
The only thing you must do to start a Sole Proprietorship in Alabama is simply decide to start.
Again, just by taking actions that may lead to making money means that you’re now a Sole Proprietor. You don’t have to file a document to “form” your Sole Proprietorship with the state.
However, there are a few things you may need to (or want to) do in order to operate legally. For example, your business may need a license or permit to operate.
And it’s best practice to open a separate business bank account.
You might also want to get a DBA (for branding), and an EIN Number (so you aren’t putting your social security number on invoices or contracts).
We’ll walk you through each of these steps below.
Step 1 – Business Planning Stage
Once you have a business idea and have decided to operate as a Sole Proprietor, it’s a good idea to establish some key components of the business.
Some things that are helpful to think about are:
- business model
- business name
- startup costs
- marketing ideas
- business address
Your business model is how your Sole Proprietorship plans to make money – what will you sell, how it’s made, how it’s delivered, how it’s marketed or advertised, etc.
It’s a good idea to think of marketing ideas early on to help your business succeed. A good marketing plan can include developing a logo and brand name, deciding where to advertise, building a website, and developing a social media strategy.
You should also choose a primary business address. This can be an actual office address, but it doesn’t have to be. It could be your home address or you could even rent a mailbox address. The purpose is to have one designated address where all mail for the business is sent, and that you can use on official documents.
Step 2 – Name your Sole Proprietorship and Obtain a DBA
Now that you’ve done some business planning, you have the option to name your company.
By default, a Sole Proprietorship’s name is the owner’s legal name. However, if you’d rather do business under a different name, you can file a DBA name (Doing Business As name).
For example: Felipe Cruz is starting a wedding planning business. Instead of having to do business under his full name – Felipe Cruz – he’d like to do business under the name “Excellence in Events”. In this case, he’ll need to register his DBA name “Excellence in Events”.
Having a DBA name can make it a lot easier to brand and market your business. It can also make your business sound larger than a one-person business.
Having said that, a DBA name is not required for a Sole Proprietorship in Alabama. If you’d rather do business under your first and last name, that is 100% okay.
Note: In Alabama, a DBA is technically called a Trade Name, however, they mean the same thing.
How do I get a DBA?
To register your DBA (aka Trade Name) in Alabama, you’ll need to submit an Online Trademark Application and pay a $30 fee.
Need to save time? We recommend hiring MyCompanyWorks ($99 + state fee) to file your DBA.
Step 3: Get an EIN from the IRS
By default, a Sole Proprietor uses their Social Security Number (SSN) for tax and financial reporting.
However, a Sole Proprietor also has the option of getting an EIN Number (Employer Identification Number) from the IRS.
Notes: Whether or not you get an EIN for your Sole Proprietorship will not impact your taxes. Your taxes will be filed the same either way.
An EIN is also called a Federal Tax ID Number, Federal Employer Identification Number, Employer Identification Number, or FEIN. They all mean the same thing.
Getting an EIN for your Sole Proprietorship may be a good idea for a few reasons:
Safety (prevent identity theft)
Without an EIN, you may need to use your SSN when dealing with vendors and clients. For example, if a client pays you more than $600 per year, you’ll need to provide them with IRS Form W9.
Instead of using your SSN, you can list your EIN instead on Form W9.
The same thing can also apply to online account setups and other places you may do business with.
By using your EIN, you don’t have to give out your SSN as much.
In this case, an EIN isn’t optional; it’s required. If you want to hire employees for your business, you will need to obtain an EIN first. This is because an EIN is required in order to pay payroll taxes for your employees.
Note: As a Sole Proprietor, while you are considered self-employed, you are technically not an employee.
Step 4 – Research business license requirements
When researching required business licenses, it’s a good idea to check if there are state-level requirements. After doing so, you’ll want to research any local requirements, those enforced by the county or city where you’re doing business.
Good news, Alabama doesn’t require a “general” business license at the state-level for Sole Proprietors. So there’s nothing to do for this step.
However, depending on your industry, and where you’re doing business, you may need an industry-specific license or a license issued by your municipality (ex: county or city).
Tip: Save time by hiring an expert. We recommend using IncFile ($99) to handle the business license research for you.
Step 5 – Maintain your business
Once you have established your Sole Proprietorship, there are a few things to do in order to keep it in good working order.
Getting a business bank account, maintaining business financial records, and filing taxes are all part of making your business run smoothly.
Business Bank Account
It’s important to open a business bank account for your Sole Proprietorship.
Keeping business finances separate from personal finances is an important part of operating a business safely.
Business bank accounts typically allow you to process more transactions per month than a personal bank account, and have other benefits.
Some banks may require a DBA in order to open a business bank account for a Sole Proprietor. We recommend calling the bank to see if a DBA is required or if you can open the business account in your own name.
While you’re on the phone, it’s also a good idea to ask about the products they offer, and what documents they require.
For example, most banks require you to bring your photo ID, and if you have them: your EIN Confirmation Letter and DBA filing.
Most states require that businesses keep certain records. There is no law specifically governing Sole Proprietorships, however, it’s a good idea to keep the following records for your Sole Proprietorship:
- Copies of tax returns for the previous three years
- Copies of any financial statements for the previous three years
If you’re just starting out, you won’t have these records right away, and that’s okay. Just keep them saved and organized as time goes on.
We recommend establishing a specific location to store the records. For example, a filing cabinet in your house or at the business’s office location. Or an online cloud storage system where you scan and save all the documents.
File your taxes (or hire an accountant)
As mentioned above, when operating as a Sole Proprietor, you’ll report your business profits or losses on your personal tax return.
While you can file your taxes yourself (using a software like Turbotax), you may want to hire a professional instead.
If so, we recommend that you hire a business accountant. Check out our guide on how to choose an accountant.
While a Sole Proprietorship may seem easier and less expensive than starting a legal entity (like an LLC), it can be risky (no asset protection) and still requires paperwork for a DBA name and business license.
In general, we don’t see many good reasons to operate as a Sole Proprietorship and we don’t recommend them. They only have disadvantages when compared to legal entities.
The exception to this would be if you really don’t have money to pay for an LLC, especially if your state has expensive fees. For some, a Sole Proprietorship may be the only option to getting your business off the ground and earning profit. In this scenario, a Sole Proprietorship can be a good place to start.
If you’d like to learn more about LLCs, check our our guide on Starting an LLC in Alabama.
Alabama Sole Proprietorship FAQs
What is better LLC or Sole Proprietorship?
While starting a Sole Proprietorship is easy, the advantages end there.
Sole Proprietorships offer no personal asset protection. If your business is sued, you’re personally liable for the business debts and obligations. On the other hand, if you form an LLC, your personal assets are protected if your business is sued.
Sole Proprietors are also seen as less official and less legitimate than a formal entity like an LLC.
We recommend forming an LLC instead of a Sole Proprietorship. Not only does it offer personal asset protection, but they are more credible, and there’s no difference between how you file taxes for a Sole Proprietorship and an LLC.
How do I make myself a Sole Proprietorship?
There is no form to file to start a Sole Proprietorship. Simply by engaging in activities with the goal of making money, you are operating as a Sole Proprietor.
However, if you’d like to do business under a name besides your first and last name, you’ll need to register a DBA (Doing Business As) Name.
Are Sole Proprietorships required to register in Alabama?
You don’t have to register your Sole Proprietorship with the Alabama Secretary of State. It simply exists once you decide to start a business and engage in business activities.
However, if your Sole Proprietorship will use a DBA (aka Trade Name), then that needs to be filed with the Alabama Secretary of State.
Additionally, you should check with an accountant in Alabama about whether your Sole Proprietorship needs to register with the Alabama Department of Revenue for things like sales tax or other types of taxes.
Can a DBA be a Sole Proprietorship?
A DBA isn’t a Sole Proprietorship. A DBA is just a “nickname” for something else – whether that’s a business or person(s).
Having said that, your Sole Proprietorship can do business using a DBA (doing business as) name.
For example, the default name for a Sole Proprietorship is the first and last name of the owner (like: Bob Barkley). However, if you’re running a bagel shop, you can file a DBA called “Bob’s Bagels & Sandwiches” in order to better brand and market your business.
How are Sole Proprietorships taxed?
Any profit or loss from your business is reported on a Schedule C with the Internal Revenue Service (IRS).
And the Schedule C is included with the rest of your personal tax return (Form 1040).
What’s the difference between a Sole Proprietorship and a Partnership?
A Sole Proprietorship is an informal business structure with one owner.
A Partnership, aka General Partnership, is an informal business structure with two or more owners.
While both structures have pass-through taxation, a Partnership needs to file Form 1065 at tax time, while a Sole Proprietorship doesn’t. Instead, a Sole Proprietor needs to include a Schedule C on their personal tax return.