What Is a Sole Proprietorship? The Complete Guide

A sole proprietorship is an unincorporated business with one owner. It's the simplest business structure and most popular option for one-person operations.

If you’re wondering if a sole proprietorship is the right solution for your business, follow along to learn more about the pros and cons of this business structure.

Sole proprietorship: Definition and examples

A sole proprietorship is an unincorporated business with only one owner who assumes unlimited liability. A sole proprietor is the business owner who oversees the sole proprietorship.

Under this business structure, there is no legal distinction between the sole proprietor and the business entity. In other words, the business owner is personally liable because they receive all the business profits, but they are also responsible for the business's debts and losses.

Key characteristics of a sole proprietorship

The following are some main features of sole proprietorships:

• A sole proprietorship is the easiest business structure to establish because the business owner doesn't need to file any paperwork or pay formation fees.
• It's common for a small business owner to start a sole proprietorship before transitioning to a limited liability company (LLC) or corporation.
• Sole proprietors are considered self-employed individuals.
• Sole proprietors have unlimited liability because the business is not considered a separate entity, so they are personally responsible for their business debts and financial obligations.
• All business profits go directly to the sole proprietor.
• Sole proprietors can hire employees but can't have joint business owners.
• This business is a pass-through entity, meaning the business income is taxed on the sole proprietor's personal income tax return.

Sole proprietorship examples

A sole proprietorship is a favorable business structure because it's flexible and easy to set up. Essentially, you can become a sole proprietor when you're the only owner and start conducting business.

Some entrepreneurs choose this business structure because it doesn't require start-up fees, while others prefer this avenue when starting a side hustle or engaging in seasonal work since it doesn't involve a lot of initial legwork.

Sole proprietorships tend to be small businesses in low-liability risk fields. Some sole proprietorship examples include the following:

• Freelancers like writers, editors, photographers, and graphic designers
• Independent contractors, such as plumbers and electricians
• Consultants
• Personal trainers
• Accountants and financial planners
• Retailers for small shops, online businesses, or service operations

Sole proprietorship advantages

Sole proprietorships offer many benefits to business owners. The following are just a few reasons why many business owners choose this legal entity when forming their businesses:

Ease of formation

Forming a sole proprietorship doesn't require you to take any formal legal action, so you don't have to worry about filing paperwork, paying formation fees, or complying with certain business entity regulations. Therefore, you can establish your sole proprietorship simply by being the owner and starting your business operations.

Since this business structure doesn't require navigating the formation process, it provides a low-effort option for those new to entrepreneurship.

Control

As a sole proprietor, you have full control over your business. Unlike other business structures, you don't have to receive approval from capital owners, like shareholders or partners, when making a business decision. You can call the shots without going through the decision-making process.

With complete control over your business, you have the freedom to run your business as you see fit.

Taxation

Another advantage is that this business structure has a lower tax burden. The Internal Revenue Service (IRS) sees sole proprietorships as pass-through entities, which means the income is passed on to you, the business owner, at the personal level. This also means your business is not subject to double taxation since you only have to pay taxes on your individual income tax return.

This pass-through taxation can offer potential tax benefits for business owners. For example, the Tax Cuts and Jobs Act (TCJA) is a tax reform that lets business owners deduct up to 20% of their qualified business earnings until 2026.

Sole proprietorship disadvantages

It's important to consider some of the disadvantages of this business structure, too.

Personal liability

Sole proprietors have unlimited liability, so there is no legal separation between their business assets and their personal assets. Therefore, you are legally responsible for your business debts.

Not only can creditors go after your personal assets to cover your debts, but a plaintiff could sue your business in your name. You are on the line for legal obligations associated with your business, too.

Because business owners assume personal liability, sole proprietorships are often considered high-risk business structures.

Raising capital

If you need to raise money for your business, the issue of unlimited liability may come up again. Many banks and investors are reluctant to give loans to unincorporated businesses because there is a higher financial risk if their businesses fail.

Another drawback is that sole proprietors can't sell stock, so their businesses don't have stockholders, further limiting their funding.

Without loans or stock, you may have to rely solely on your personal savings to fund your business idea.

How to start a sole proprietorship in 6 steps

The good news is that starting a sole proprietorship is fairly simple. Follow these six steps to get your business off the ground.

1. Plan your business

Once you've come up with a business idea, we recommend drafting a business plan. This will help you consider all the moving parts of your business, from your target audience to your competition.

What kind of products and services do you want to offer? What kind of demand is there for them? And how do you plan to market and fund your idea? Do some market research, learn about the industry, and run the numbers so that you have a solid plan for moving forward.

2. Register for a DBA

If you wish to operate under a name other than your own name, you'll need to register for a “doing business as” (DBA) name, also called an assumed name, trade name, or fictitious name. This lets you select a unique name for your sole proprietorship that’s different from your own name. While it's optional in some states, others require it.

LegalZoom offers convenient DBA services that oversee the registration process. We'll ensure your DBA name complies with state or county regulations and register it with the correct state or county government agency.

3. Obtain licenses and permits

Although there is no formal process for establishing this kind of business, you may still need to acquire business licenses and permits.

Some states require every business to obtain a general license, while others only require local and federal licenses that apply to certain business activities. For instance, if you're a cosmetologist or athletic trainer, you may need an operational license to provide specific services. Other licensing examples include zoning permits, health permits, and seller's permits.

LegalZoom can help you determine what licenses and permits apply to your business.

4. Apply for an EIN and state taxes

If you're not planning to hire employees, the Internal Revenue Service allows you to use your social security number (SSN) for tax purposes. However, if you foresee needing employees in the future, it's a good idea to apply for an employee identification number (EIN). You can hire LegalZoom to file your EIN paperwork for you.

Depending on your state and business operations, you may need to register for additional taxes, such as sales tax and payroll taxes (if you hire employees). You are also responsible for the self-employment taxes, which include Social Security and Medicare taxes.

Some banks may require an EIN if you wish to open a business bank account.

5. Open a business bank account

It’s a good idea to open a business bank account. This helps separate your business assets from your personal assets, which makes it easier to track your business expenses, especially when it comes time to pay taxes.

6. Launch your sole proprietorship

Now, you're ready to kick off your business! In addition to providing customers with your products or services, start implementing your marketing strategies and establishing your online presence with a registered domain name, social media accounts, and website.

Also, as you start conducting business, remember to maintain records of your income and expenses to monitor your business's financial health.

Sole proprietorship vs. LLC

You may have heard of an LLC, but what's the difference between a sole proprietorship and an LLC?

An LLC is an unincorporated business structure that exists as a separate entity from its owner. The main difference between the two is that an LLC enjoys some degree of liability protection.

Let's take a closer look at sole proprietorships vs. LLCs.

Formation and maintenance

When comparing the formation and maintenance of these two business structures, sole proprietorships are more flexible, more affordable, and easier to establish. Aside from registering for a DBA, which isn't even always necessary, a sole proprietorship doesn't have any formal registration requirements.

An LLC, on the other hand, must comply with specific regulations. For example, all LLCs must file articles of organization with the state and pay the filing fee. Depending on the state in which they conduct business, some LLCs must also file annual or biennial reports along with the appropriate fees. Because of this, LLCs face more start-up costs and red tape than their counterparts.

Tax considerations

While sole proprietorships are always taxed as pass-through entities, LLC owners can decide how they want to be taxed. They can choose to be taxed at the personal level, like sole proprietors, or at the corporate level, depending on their business situation.

Liability and risk

Sole proprietorships assume unlimited liability, while LLCs have some liability protection. This means that the business owner and the LLC are considered separate entities, so their personal assets are protected from lawsuits and creditors.

Because an LLC owner's finances are not tied up in their business, an LLC has a lower liability risk than a sole proprietorship.

Why and when to form an LLC

Sole proprietorships are a good option for small business owners just starting out, but as your business grows, you may want to consider forming an LLC.

Not only do LLCs offer liability protection, but they allow you to bring on partners and make it easier to obtain loans, allowing you to raise more capital for your business. Establishing an LLC can also make your business more credible in the eyes of banks, investors, and potential customers and clients.

If you're ready to form your own LLC, turn to LegalZoom. Our LLC formation services oversee the entire process, ensuring your business is compliant with local, state, and federal requirements.

FAQs

What does sole proprietor mean?

A sole proprietor is the business owner who owns and operates the sole proprietorship.

What happens to a sole proprietorship if the owner dies?

Usually, a sole proprietorship dies with the owner, so the business assets and debts become part of the deceased's estate.

How are sole proprietorships taxed?

Sole proprietorships are taxed as pass-through entities, meaning the owner reports their business profits and losses on their personal income tax return.

Do I need to file a BOIR for a sole proprietorship?

No. Because sole proprietorships are not considered legal entities, they do not need to file Beneficial Ownership Information Reports (BOIR) with the Financial Crimes Enforcement Network (FinCEN).

Is a sole proprietorship the same as being self-employed?

Yes, a sole proprietorship is considered the same as being self-employed because you are responsible for running the business on your own.