Sole Proprietorships: Everything You Need to Know

A sole proprietorship is the simplest and most common business structure in the United States. It refers to a business that’s owned and operated by one individual with no legal distinction between the owner and the business entity.

Of course, there are many other business structures to choose from. Alternatives to sole proprietorships include S corporations,  C corporations and limited liability companies (LLCs). Each has unique attributes and benefits, and all three will generally shield your personal assets from business liability — something a sole proprietorship won’t do. Still, many entrepreneurs choose to become sole proprietors because the flexibility, low startup costs and ease of management outweigh the added protections that come with formal incorporation.

The type of business you set up will affect your ability to find investors and attract customers, so it’s essential you weigh the pros and cons carefully. Business structure also impacts how much you spend to run your business and how you pay taxes. Essential questions to ask include:

• What is a sole proprietorship in business terms compared to other options, like an LLC, S-Corp or partnership?
• What is a sole proprietorship in business going to offer me that other business structures can’t?
• What are the long-term implications of starting out as a sole trader?
• Can I convert to another business structure later if my company grows?

Read on to learn more about the ins and outs of being a sole proprietor.

Sole Proprietorship Definition

The two primary characteristics that define sole proprietorship status are:

1. The business and business assets are owned by one individual proprietor.

2. There’s no legal separation between the business and the owner.

That means if the business gets sued, the owner assumes personal liability, which makes them responsible to pay out of pocket for legal defense costs and settlement money if the business profits are not enough to cover the fees and damages.

If you’re wondering, “What is a sole proprietorship’s advantage over other company structures, given my level of risk and financial responsibility as the only owner?” An unincorporated business owned by just one person is by far the simplest type of legal entity to start and operate. This is because you don’t have to jump through all the hoops that incorporation entails, such as filing paperwork annually with your state and complying with the procedural rules of incorporation.

Many business owners—especially solo entrepreneurs who don’t plan to hire employees—choose to remain sole proprietors and not incorporate because of the simplicity.

Characteristics of Sole Proprietorship

Here’s a list of defining features that set sole proprietorships apart from other business structures:

• Ease of formation: Minimal paperwork is required in most states.

• Low admin costs: No formation fees or ongoing compliance in most cases.

• Full control: You make all business decisions without board approval or partners.

• Direct profit ownership: All profits go straight to you and are taxed as personal income.

• Personal liability: You’re on the hook for any debts or legal issues.

• Simple tax setup: The business doesn’t file its own income tax return.

• Flexible naming options: Operate under your legal name or file a DBA.

As you can see, sole proprietorships are lean and built for speed, making them ideal for entrepreneurs who want to hit the ground running.

What Qualifies You as a Sole Proprietor?

You are considered a sole proprietor if you own and operate an unincorporated business by yourself, regardless of whether it’s a full-time business or a side hustle. Examples include:

• Working as a freelancer, consultant or gig worker.

• Selling products online or in person under your own name.

• Providing services like tutoring, landscaping, photography or pet care.

• Running a blog or YouTube channel that earns income.

• Offering fitness training, coaching or wellness services.

In short, if you’re earning self-employment income and reporting it on a personal tax return, you’re likely operating as a sole proprietorship by default.

How To Start a Sole Proprietorship in 4 Steps

What is a sole proprietorship’s biggest appeal? Most entrepreneurs will tell you it’s that starting one is incredibly easy. Whenever you start a business by yourself, you’re automatically a sole proprietor by default unless you actively choose to incorporate or form a limited liability company (LLC). That said, here are the basic steps of starting any business, including a sole proprietorship:

1. Create a business name.

For tax filing purposes, you’ll need to decide on a business name. This could simply be your full personal name (“Terry Smith”), or it can be a fictitious business name (“Smith Consulting” or “Pinnacle”).

Keep in mind that if you choose to create your own business name, your state probably requires it to be distinguishable from other registered businesses. That’s a smart business idea anyway, due to common and federal trademark protection rules.

2. Obtain any required business licenses or permits.

Depending on the type of business you’re starting, your local or state government may require you to obtain particular types of licenses or permits in order to legally operate. Check out your state’s business licensing website.

3. Open a business bank account.

Sole proprietors who operate under their own name—rather than “doing business as” under a fictitious name—can generally keep their business net income in their personal bank accounts. But keeping them separate is often beneficial, as it allows you to keep better tabs on your company’s finances by not intermingling them with your personal finances.

If you plan to seek outside financing for your business, you’ll want to be able to show that you’re managing your business diligently and not mixing all the profits with your personal assets too much.

4. Create a website.

Although it’s not a formal requirement for starting a business, having a website is immensely valuable to any business today—and should typically be considered a first step. It’s an easy way for customers and prospects to learn about your company and find you online.

5. Protect Your Sole Proprietorship.

Unlike with other business structures, like LLCs, sole proprietors can be held personally liable for anything that happens within the business. For entrepreneurs with significant personal assets, this represents considerable risk, so it’s important to protect yourself with sole proprietorship insurance or professional liability insurance for sole proprietors. The proper coverage helps protect you against liability claims, like customer slip and falls, lawsuits and data breaches.

Advantages of Sole Proprietorships

Thanks to its simplicity and lack of reporting requirements, being a sole proprietor can offer several advantages. For one, if you run the business under your personal name, you generally don’t need to register your business name with your state or worry about trademark protection. This makes it ideal for startups, contractors, side businesses, and home-based businesses that don’t want to spend the time or energy worrying about lots of formalities.

Here are the top benefits of being a sole proprietor:

Affordable to Start and Operate

Other than paying for any required permits or licenses required in your industry or by your state, the required costs to start a sole proprietorship are typically little to none.

You Can Set Your Own Hours

Because you’re essentially considered self-employed, you’re in charge—so you have complete control over your schedule. Many sole proprietors work from home due to the flexibility it provides them.

You Own 100% of the Business

Because you are the sole owner, you keep all of the income generated by the business. As the sole proprietor, you call the shots and don’t have to compromise with other owners.

Taxes and Record Keeping Are Easier

As a sole proprietor, you’re considered a pass-through entity, meaning there’s no need to submit a separate income tax return to the Internal Revenue Service (IRS). With pass-through taxation, all income or losses to the business are reported on your personal tax return, along with your income tax withholding, Social Security administration and Medicare contributions.

Business Losses Are Deductible

You can generally deduct any business loss from other personal income on your tax return. And if you don’t have any other income in the year you’ve experienced the loss, that loss can be “carried forward” and deducted against your income in future years.

Keep in mind that it’s very common for businesses to have losses in their early years, as they tend to have many start-up costs and may not be generating enough income to offset those expenses.

Sole Proprietorship Disadvantages

What are the main disadvantages of a sole proprietorship? Some of the disadvantages to consider before choosing a sole proprietorship as your business structure include:

Owners Can Be Held Personally Liable for Business Activities

One of the most common reasons business owners incorporate or form a limited liability company (LLC) is that those structures provide better protection against unlimited liability. Corporations and LLCs will generally shield the owner from any legal liability the business faces and protect their personal finances. Being a sole proprietor means taking on financial risk, because if the business gets sued or has to close and owes creditors money, those costs will have to come from their personal funds.

Business Income Is Reported as Regular Income

Having to report business income on your personal tax return can have its disadvantages. One drawback is that you must report all income in the year it was generated and you don’t have the flexibility that some incorporated businesses have of timing the owner’s personal salary payments to reduce their tax burden.

Sole proprietors must pay the federal self-employment tax, which is a 15.3% tax on your net earnings, for Social Security and Medicare. (Alternatively, one benefit to being an S Corp is that the owners can potentially reduce their self-employment tax liability by taking a potentially lower salary and then distributions.)

The Burden Is All Yours

As sole owner, you’re responsible for the company’s success or failure. There’s no one else to share the pain if the company runs into financial problems or faces big challenges.

Contracts May Be More Difficult To Get

Some companies refuse to work with sole proprietors—or at least strongly prefer not to—because they think an unincorporated business is not as legitimate or as professional as an LLC or S corporation. There may also be negative tax implications that make it preferable to work with other business types instead.

Capital Is Harder To Raise

Because you are required to be the sole owner of the company, it can be harder to raise capital and attract investors, especially those looking to make equity investments. In a sole proprietorship, you can’t give away shares of your company, so you would have to find other non-equity-granting ways to raise money.

The Business Is Harder To Sell

Because the business is all yours—and may give off the impression that you are closely intertwined with the business’ success—it can be harder to sell a sole proprietorship. This may be especially true if the business is run under your personal name and you haven’t taken steps to establish a brand identity for your business that isn’t too tied to your personal identity. 

How Does a Sole Proprietorship Pay Income Tax?

Sole proprietors report all business income on their personal tax returns by completing a Schedule C. The Schedule C lists the taxable income as well as any deductible business expenses. These expenses can include equipment or office supply purchases, home office expenses or auto expenses and gas mileage for business-related trips.

Though the income is reported on the annual tax return, sole proprietors generally must pay income taxes throughout the year by filing quarterly estimated tax payments to cover taxes for both their income and their self-employment tax. By filing estimated taxes, sole proprietorships don’t have to worry about facing a lump-sum tax payment at year-end, nor the penalty they could face by not paying estimated taxes.

The federal government only requires estimated taxes to be paid if the business owner expects to owe more than $1,000 in taxes annually.

It’s also important to note that if you anticipate owing at least $1,000 in taxes annually, you’ll need to make estimated tax payments as a sole proprietorship. Sole proprietors can also apply for home office deductions. To do this, you need to use the IRS Form 8829, Expenses for Business Use of Your Home.

There are also requirements around tax years you’ll want to be aware of. For instance, S Corps are usually required to follow a calendar year instead of a fiscal year. Tax professionals can help you file your taxes and answer any questions you have.

Do Sole Proprietors Need an EIN?

Sole proprietors don’t need an Employer Identification Number (EIN) to work and operate as self-employed individuals. However, you will need one if you plan to hire employees, operate as a trust or estate, work with nonprofits or open a business bank account in your business name. Some vendors and banks may also require an EIN, even if the IRS doesn’t.

Sole Proprietorships vs. Other Business Structures

It’s vital to fully understand your options from the get-go. For example, what is a sole proprietorship business going to offer you in terms of cost, control and flexibility that an LLC or corporation can’t? And how do those trade-offs affect your taxes, liability and ability to grow? Here’s a direct breakdown of how a sole proprietorship stacks up against the other main options:

• What is a Sole Proprietorship vs. an Independent Contractor?: A sole proprietorship refers to your business structure in terms of how it is owned and taxed. An independent contractor refers to the way you work and the contractual relationships you have with clients. Many independent contractors operate as sole proprietors by default, but the two terms aren’t interchangeable.

• What is a Sole Proprietorship vs. an S Corp?: S Corps allow profits and losses to pass through to shareholders’ personal tax returns while offering limited liability protection. They involve more rules and paperwork to set up and run, but also more tax and liability advantages–especially if your business generates substantial income.

• What is a Sole Proprietorship vs. an LLC?: A limited liability company is a completely separate legal entity that protects your personal assets from business debts and lawsuits. However, LLCs require state registration, fees and ongoing compliance, making them more complex—and more expensive—to manage.

• What is a Sole Proprietorship vs. a Partnership?: A partnership is formed when two or more people own and operate a business together, whereas a sole proprietorship has only one owner. Partnerships involve shared decision-making and liability, while sole proprietors retain full control but bear all the risk themselves.    

Ultimately, the right structure depends on your goals, risk tolerance and growth plans. Sole proprietorships offer unmatched simplicity and control—but that simplicity comes with personal liability. Here’s a side-by-side comparison of all the defining features. 

	Sole Proprietorship	Independent Contractor	S Corp	LLC	Partnership
Structure	One individual owns and operates the business	An individual hired under contract	A corporation electing S status with the IRS	A separate legal entity owned by one or multiple people	Two or more owners share control and responsibility
Taxation	Pass-through taxation on the owner’s personal return	Self-employment taxes are reported on the worker’s personal return	Pass-through taxation to shareholders’ personal returns	Default pass-through with an option to elect corporate taxation	Default pass-through with an option to elect corporate taxation
Advantages	Simple setup, low cost, full control, direct profits	Flexibility, choose clients/projects, low setup cost	Liability protection, potential tax savings, investor credibility	Liability protection, flexible management, customer credibility	Shared resources, complementary skills, simple to form
Disadvantages	No liability protection, harder to raise capital	No liability protection, irregular income, limited benefits	Complex setup, strict rules, higher costs, shareholder limits	State fees, compliance requirements, more costly	Shared liability, risk of disputes, profits must be split

Can You Change an LLC to a Sole Proprietorship?

Yes, you can change an LLC to a sole proprietorship by dissolving the LLC and continuing business operations as an individual. However, keep in mind that you’ll lose the limited liability protection it provided. Additionally, you must formally cancel the LLC registration with your state, update your licenses and tax records and notify the IRS of the changes.

Example of a Sole Proprietorship

In 1989, Annie Withey began selling organic macaroni and cheese to New England supermarkets. She decided to remain a sole proprietor as the company grew because that simple business structure allowed her to focus her time on creating new organic food products and bringing them to market quickly.

By the mid-1990s, her company, Annie’s Homegrown, had become so successful that she had to create a separate legal entity in order to go public and sell stock. Just because you start out as a sole proprietorship doesn’t mean you have to remain one.

Famous Companies That Started out as Sole Proprietorships

In fact, many of today’s most well-known companies started as sole proprietorships and then incorporated as they grew.

Walmart Started as a Sole Proprietorship

Long before Walmart became a global retail chain, founder Sam Walton started a couple independent retail stores in Arkansas as a sole proprietor. He opened his first Walmart in 1962 and the company went public in 1970.

A Sole Proprietor Created eBay

Founder Pierre Omidyar started a small online auction website as a sole proprietorship in 1995. He was working as a software developer for another company at the time and just created it as a place for people looking to trade and collect Pez candy dispensers. He incorporated his business, then called Auction Web, less than a year later, and eventually grew it into the huge online marketplace it is today.