How to Start a Sole Proprietorship in Alabama

What is a sole proprietorship?

A sole proprietorship is the simplest form of business entity. It is owned and operated by a single individual responsible for the business’s finances and debts. They are easy to set up and, for this reason, is popular amongst solo entrepreneurs and business owners. Unlike other business structures like LLCs or corporations, there is no legal separation between the business and the owner.

While a sole proprietorship offers simplicity and flexibility but has some drawbacks. The main disadvantage is the lack of asset protection. As a sole proprietor, your 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 Alabama sole proprietorship

Choose a business name

By default, the name of the sole proprietorship must be the same as the owner’s legal name.

If you want to use a different name, you must file a “Doing Business As” (DBA), which is known as a trade name in Alabama.

Here is how you file a DBA:

Choose a business name: Brainstorm ideas for your name. Try to think of a memorable name that describes what you do.
Check availability: Before finalizing your name and filing your DBA paperwork, check if it is available in Alabama. Visit the Alabama Secretary of State’s website and complete a name search for existing business names.

Filing a trade name in Alabama is the same process as filing a trademark. Double-checking your name is unique, and cross-checking with the Alabama trademark records is important.

Check online availability: Don’t forget to check if the corresponding domain name and social media handles are available.
Register the business name: Once you’ve confirmed the availability of your chosen name, you may register it as a trade name. Complete the “Application to Register Trademark, Service Mark or Trade Name in Alabama” form and return it with a $30 filing fee to the Office of the Secretary of State.

You can apply for your trade name here.

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 personal 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’s required for reporting taxes and other documents to the IRS and for setting 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 Alabama business licenses, permits, and zoning clearances

When researching business licenses, you should check if there are any state licensing requirements. After doing so, you’ll also want to research any requirements the local government may have where you plan on doing business.

Alabama doesn’t require a general state-level business license. Depending on the type of business you run, you may have to apply for industry-specific licenses. The Division of Business and Licenses manages these licenses at the Department of Revenue.
Alabama does require you to obtain a business privilege license from the County where you will do business. Typically, the county probate judge is responsible for issuing this license. Look at the business privilege license page on the state’s Department of Revenue website for more detailed information.

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.

Access the most current versions of Form 1040, Schedule C, and Schedule SE on the IRS website.

Additional state and local taxes

Visit the Alabama Department of Revenue website to register for additional state taxes. This may include sales tax, income tax, or other business taxes, depending on your business activities.

If you’re uncertain which specific taxes pertain to your business, it’s a good idea to register with the MyAlabamaTaxes portal. This tool will automatically enroll you for state taxes relevant to your business.

For instance, businesses that sell alcohol or tobacco products will need to pay excise taxes on those items, or sole proprietors that operate short-term vacation rental properties may also owe occupancy taxes in addition to their regular tax obligations.

Additional steps

Once you have obtained your EIN, registered for any federal taxes, and obtained the correct licenses, you have completed all the steps needed to start your sole proprietorship. Below, we will outline some extra steps to stay compliant and organized as a small business.

Open bank accounts

Separating your personal and business finances is essential for keeping accurate records and protecting your personal assets. Consider the following:

Business bank account: Opening a business bank account to manage your business finances separately will help you track income and expenses, simplify tax reporting, and can help establish credibility.
Business credit card: A business credit card can also help keep personal and business expenses separate. This will make it easier to track business-related expenses and build credit for your business which can be useful further down the road.

Get general liability insurance

Because sole proprietors have no liability protection for all debts and obligations of the business, they should consider taking out an insurance plan. A business liability insurance policy can offer financial protection against unforeseen events.

General business liability insurance: This insurance covers property damage, bodily injury, and personal injury claims against your business.
Professional liability insurance: Professional liability insurance can protect you from claims of negligence or errors if you provide professional services, such as consulting or advising.

Maintain business records

Alabama requires new businesses to maintain complete and accurate accounting records. Detailed record-keeping helps maximize tax deductions and organize your finances.

We recommend keeping records of the following:

Income earned
Expenses
Assets/liabilities
Inventory
Receipts

We recommend using bookkeeping software, spreadsheets, or an organized filing system to stay on top of your record-keeping. This will ensure you have all the necessary documentation come tax time.

Sole proprietorship vs. LLC

For some small businesses or startups, forming an LLC may be preferable to a sole proprietorship.

Here are some key advantages an LLC holds:

Liability protection: LLCs legally separate your personal and business assets. Sole proprietorships do not.
Credibility: An LLC’s structure appears more professional with customers.
Growth potential: LLCs are better suited if you plan to expand your business.
Tax flexibility: LLCs allow you to choose how your business is taxed. Sole proprietorships do not.

However, there are tradeoffs to consider:

Complexity: LLCs require an operating agreement and annual reporting. Sole proprietorships have less paperwork.
Cost: LLC formation and maintenance fees are higher than a sole proprietorship.

Tips

Consult a tax professional to decide which structure best fits your business.
Weigh liability protection vs simplicity based on your goals and risk factors.

Useful resources to help start your sole proprietorship in Alabama

FAQs

Do I need a registered agent for my business in Alabama?

As a sole proprietorship, you’re not legally required to have a registered agent in Alabama. However, having one can provide additional privacy and peace of mind. If you have an LLC a registered agent is mandatory.

What risks are involved in running a sole proprietorship?

One of the main risks is unlimited personal liability. If your business incurs debts or is sued, your personal assets could be used to cover these obligations.

Can a sole proprietor hire employees?

Yes, a sole proprietor can hire employees. However, once you do, you must obtain an Employer Identification Number (EIN) from the IRS for tax purposes.

How does a sole proprietor pay taxes in Alabama?

Sole proprietors must report their business income and expenses on their personal tax returns. They use IRS Form 1040 and Schedule C.

Is it easy to transition from a sole proprietorship to a Limited Liability Company (LLC) or corporation?

It’s generally straightforward to transition to an LLC or corporation, but it requires additional paperwork and more complex rules and regulations. Having an EIN as a sole proprietor can simplify this process.

What is the difference between a general partnership and a sole proprietorship?

A general partnership involves two or more individuals who share the business’s ownership, profits, and liabilities.

What is the difference between a business license and a business privilege license in Alabama?

A business license is an industry-specific permission from the state, while a business privilege license is a general tax required by most local governments in Alabama.

Does my sole proprietorship need a separate business address in Alabama?

You don’t need a separate business address by law in Alabama, but having one looks more professional, keeps business and personal mail separate, and eases transitions if you move or expand.