Starting a sole proprietorship tends to appeal to new businesses, especially since it’s an easy and inexpensive process. However, it’s important to make sure you understand the benefits of doing so and plan carefully to prevent expensive errors and build a strong foundation for success.

In this article, we’ll go over the details of sole proprietorship in Germany, along with its pros and cons, and the taxes involved. We’ll also explain how to establish a sole proprietorship and the costs you’ll face in the process.

What’s in this article?

• What is a sole proprietorship?
  
• Why should I set up a sole proprietorship?
  
• What are the pros and cons of a sole proprietorship?
  
• How do I set up a sole proprietorship?
  
• What taxes do sole proprietors have to pay?
  

What is a sole proprietorship?

A sole proprietorship is a business founded, owned, and run by one single person – i.e., a sole proprietor. The sole proprietor is the only owner of the business, and they are fully responsible for managing the business. This distinguishes sole proprietorships from corporations, which might have multiple owners or investors. However, like corporations, sole proprietorships can hire employees.

Sole proprietorships are not explicitly defined by law. Therefore, founders can choose from several legal forms. They can incorporate their business as a:

• Small business
  
• Freelance professional
  
• Registered trader
  

Small businesses and traders are considered commercial sole proprietorships, while freelance professionals run non-commercial sole proprietorships. According to Section 18 of the Income Tax Act, freelance professions include activities in science, art, literature, teaching, and education, as well as the professional activities of doctors, lawyers, notaries, engineers, architects, tax consultants, auditors, and translators. The list of eligible professions is extensive and includes more than just those specifically named in the Income Tax Act.

Sole proprietorships must be distinguished from corporations, which can also be formed by a single person: the one-person UG (small business with limited liability), the one-person GmbH (limited liability company) and the one-person AG (a public corporation). These must meet stricter legal requirements, but they offer limited liability, unlike sole proprietorships.

Small-scale entrepreneurs are often confused with sole proprietors. A sole proprietorship can be a small-scale entrepreneur, but that’s not always the case. The key factor is the amount of annual sales: according to Section 19 of the Value-Added Tax (VAT) Act, small-scale entrepreneurs must have had a turnover of less than €22,000 in the previous year and less than €50,000 in the current year. If a sole proprietorship meets these turnover limits, it is classified as a small-scale entrepreneur. If the turnover exceeds the legal limits, the sole proprietorship is not classified as a small-scale entrepreneur. In addition, companies such as a GbR (civil law partnership), OHG (general partnership), or KG (limited partnership) may also be classified as small-scale entrepreneurs.

Why should I set up a sole proprietorship?

A sole proprietorship can be established with minimal financial investment. However, this is not the only advantage. There are many other benefits of a sole proprietorship:

• Sole proprietorships are a good fit for many industries and services, and they are flexible enough to adapt to market changes.
  
• The legal form allows for quick setup without lengthy approval procedures.
  
• Sole proprietors have the freedom to make independent decisions and run the business according to their own vision.
  
• All profits go to the sole proprietor. This is because they have exclusive control over the capital generated.
  
• Direct taxation of profits makes tax filing simpler.
  
• Sole proprietorships tend to have closer customer relationships because interactions are usually personal.
  

What are the pros and cons of a sole proprietorship?

There are several advantages to starting a sole proprietorship, but there are also some disadvantages to be aware of. Here are a few key things to keep in mind.

Pros of sole proprietorship

Starting a sole proprietorship is much easier than starting other types of businesses. Only one person is required, so there are no formalities such as drafting articles of association. You only need to register the business with the trade office, the tax office, and the employers’ liability insurance association.

In certain circumstances, a sole proprietorship may also need to be entered in the Commercial Register and registered with the relevant Chamber of Commerce and Industry (IHK) or Chamber of Crafts (HWK). For freelancers, the set-up process is particularly straightforward, as they only need a tax number and do not need to register a business.

It is usually possible to set up a sole proprietorship online, as long as the local authorities offer digital services.

The cost of starting a sole proprietorship is minimal. Unlike corporations, there is no minimum capital requirement. There are also no notary fees, as notarisation is not required. Commercial sole proprietors must register their business and pay membership fees to the Chamber of Commerce and Industry or the Chamber of Crafts. These fees are based on the amount of profit generated. There is also a fee for registration in the Commercial Register, if required. Starting a business is particularly inexpensive for freelancers. They only need to invest in their business equipment.

A sole proprietorship can be up and running very quickly after incorporation. Professionals can get started as soon as they have their tax ID number. Commercial sole proprietors can start operating immediately after successfully registering their business. There are no long waiting periods or approval procedures that are often required for other legal forms.

Compared to corporations, sole proprietorships face fewer bureaucratic requirements. For example, there is no requirement to publish annual accounts. Bookkeeping is straightforward, especially for sole proprietorships that are not registered or that generate less than €80,000 in profits or €800,000 in sales per year. For these companies, simple bookkeeping using cash-basis accounting is sufficient. This also applies to freelance professionals. Sole proprietorships that do not meet these conditions are required to keep double-entry accounts, which means preparing a balance sheet and a profit and loss statement.

Sole proprietors often establish their businesses independently, ensuring the company is entirely under their ownership. In contrast, managing directors of a GmbH must follow instructions from shareholders. This entrepreneurial freedom also allows for quick decision-making and flexibility in day-to-day operations: sole proprietorships can quickly adapt to changing market conditions. Additionally, sole ownership ensures that all profits go exclusively to the sole proprietors.

Cons of sole proprietorship

Despite all the benefits of sole proprietorship, it has its disadvantages as well.

Sole proprietors must always take full responsibility for their business decisions and actions. They have to answer to customers, suppliers, or financiers if something goes wrong. They alone bear the entrepreneurial risk and the pressure, especially since they are fully liable with their personal assets for the company’s liabilities in the event of loss or damage. Liability cannot be limited. Therefore, in the worst case, there is a risk of personal insolvency.

Sole proprietorships that are not registered in the Commercial Register must comply with certain requirements regarding the name of their company. Small businesses must include the full name of the owner. However, suffixes or additional industry designations are allowed. Professionals must also trade under their first name and surname. These must always be listed in conjunction with any invented name or logo.

While a GmbH, for example, is subject to corporate income tax of 15%, solidarity surcharge, and trade tax, sole proprietorships pay tax on their income. The top income tax rate is 42% for incomes over €62,810. The effective top tax rate can be as high as 45% for incomes over €277,826, known as the “wealth tax.” This means that sole proprietorships face a higher tax burden than corporations.

However, it should be noted that the income already taxed within a GmbH is not available to individuals. In order for a shareholder to have access to the GmbH’s profits for personal expenses, they must usually be employed by the GmbH as a managing director or receive profits through a profit distribution, similar to a dividend. This distribution is subject to a final withholding tax of 25% plus solidarity surcharge and church tax, if applicable.

Pros and cons of a sole proprietorship

How do I set up a sole proprietorship?

If you want to set up a sole proprietorship, you can do so quickly and easily by following these steps:

• Develop the business idea: Every start-up is based on a business idea. You should carefully consider what services or products you want to offer or sell. It’s worth doing some market research to identify possible niches. As part of this first step in starting a business, you should also consider the appropriate legal form and name for your sole proprietorship. You should also create a business plan to provide personal planning security and as a basis for informing the relevant authorities.
  
• Register with the trade office: Sole proprietors must register their business if they intend to establish a sole proprietorship. This involves filling out a trade licence form and submitting it to the relevant trade office. The fee is usually in the mid double digits.
  
• Open a business account: Sole proprietors are not required to open a business account. However, it’s a good idea to do so to keep your personal and business income and expenses separate. Some banks do not allow personal accounts to be used for business purposes. You might also want to consider using specialised service providers to help you manage your finances. For example, Stripe Payments enables you to accept and manage payments from your customers. With access to over 100 payment methods, you get maximum flexibility and can offer your customers a seamless experience.
  
• Register with the tax office: The trade office will forward your sole proprietorship information to the appropriate tax office. The tax office will then send you a tax registration form to complete. Among other things, you must provide a realistic estimate of your expected turnover. This estimate forms the basis for calculating the income tax liability determined by the tax office. If you wish to apply the small-scale entrepreneur rule, you can notify the tax office accordingly. Once the process is complete, sole proprietors receive a tax identification number that they can use for invoicing in the future. Since freelancers do not register a business, the trade office does not send information about their business to the tax office. Consequently, freelancers must contact the tax office themselves.
  
• Register with the employers’ liability insurance association: Sole proprietors may voluntarily join a professional association, which automatically enrols them in statutory accident insurance. This also applies to freelancers. However, certain professions, such as nurses, geriatric nurses, midwives, and physiotherapists, are required to be insured. If sole proprietors employ staff, they must insure them under the statutory accident insurance scheme. DGUV, the umbrella organization for statutory accident insurance, offers an overview of the relevant employers’ liability insurance associations.
  
• Enrol in the Commercial Register: Sole proprietorships engaged in commercial activities that require a commercial business operation must be registered in the Commercial Register. This is especially true for merchants.
  
• Register with the IHK or HWK: Depending on the sector and activity, it may also be necessary to register with the relevant Chamber of Commerce and Industry or the Chamber of Trades and Crafts. The trade office usually completes the registration automatically.
  
• Register with the Federal Employment Agency: Sole proprietors who employ their own staff must apply to the Federal Employment Agency for a company number that uniquely identifies the business. This number will later be used to register for social security contributions for the employees concerned.
  
• Set up bookkeeping: Formally creating a sole proprietorship is one thing, but before you start operating, it’s fundamental to establish proper bookkeeping. Stripe Billing can automate your workflows and support you in managing subscriptions or issuing recurring invoices.
  
• Start marketing and business operations: Finally, it’s important to promote the sole proprietorship and discuss how to effectively reach potential audiences. Launch relevant marketing initiatives, acquire customers, and get up and running.
  

Setting up a sole proprietorship: Step by step

What taxes do sole proprietors have to pay?

Establishing a sole proprietorship also involves managing anticipated tax obligations. Depending on the size and nature of the business, different types of taxes may apply. The most important are:

• Income tax: Sole proprietors must pay income tax on their profits. The profit is considered the entrepreneur’s income and is taxed along with other sources of income.
  
• Value-added tax: If the company is registered for VAT, sole proprietorships must charge VAT on the services they provide and goods they sell, and then remit this to the tax office. Sole proprietors who have applied for small-scale entrepreneur status may be exempt from VAT.
  
• Municipal trade tax: Freelancers are generally exempt from municipal trade tax. This also applies to other sole proprietors if they make less than €24,500 in profit per year. However, even if they are under this exemption limit, sole proprietors must submit a trade tax return.