Sole Proprietorship

What Is a Sole Proprietorship?

A sole proprietorship is an unincorporated business with only one owner that makes no distinction between the business and its owner. In a sole proprietorship, the owner is responsible for all debts and liabilities but also receives all profits from the business. Consequently, the sole proprietor is responsible for paying personal income tax on that profit.

Because of the legal sole proprietorship definition that the business and the owner are one and the same, a sole proprietor can do business under their own legal name. They may also elect to use a trade name, but it is important to note that creating a trade name does not create a separate legal entity.

How to Start a Sole Proprietorship

Because a sole proprietorship is an unincorporated business, the process for forming one is different from that of other business entity types, such as an LLC or corporation.

In some cases, all the owner needs to do is begin conducting business to be considered a sole proprietorship. Because rules around registering a sole proprietorship vary from state to state, it’s best to check with the county clerk or city government in the jurisdiction where the sole proprietorship operates.

If you choose to operate a sole proprietorship under a trade name (also known as a fictitious name or a “doing business as”/DBA), your state may have to file paperwork to let the local government know about your activities. If you don’t file a DBA, you will be operating under an “assumed name,” which is just your own first and last name.

If you plan to hire employees or file taxes, you should obtain an Employer Identification Number (EIN) from the IRS. You will report your income, losses, and expenses on your personal income taxes, but be aware that you must pay self-employment taxes and payroll taxes to stay in legal compliance.

Before you begin doing business under a sole proprietorship, don’t forget to check to see whether you need a permit or license. Certain business types usually need a license or permit:

• Therapy of any type (including massage and music therapy)
• Skilled trades, such as plumbers and electricians
• Medical device or service providers
• Athletic agents or trainers
• Cosmetologists and barbers

It’s best to check with the county clerk or secretary of state’s office in your jurisdiction to see if you must obtain a license or permit before doing business as a sole proprietor.

IRS Forms That May Be Required for Sole Proprietorships

If you are doing business as a sole proprietor, you may need to use one or more forms to file your taxes with the IRS:

• Income tax: Form 1040 (or 1040-SR for those over 65) and Schedule C
• Self-employment tax: Schedule SE
• Estimated tax: Form 1040-ES
• Social Security, Medicare taxes, and income tax withholding: Form 941 (quarterly tax returns), Form 944 (annual tax returns), and Form 943 (for agricultural employees)
• Wage and tax statements: Form W-2 (goes to employees) and Form W-3 (to SSA)
• Federal unemployment tax (FUTA): Form 940
• Information returns: Form requirements vary based on business
• Excise taxes: Form requirements vary based on business

Remember that you only need to file most of these forms if you have employees. The specific forms a sole proprietor is required to file will depend on their unique business situation. It is always best to contact the IRS or consult a professional.

Sole Proprietorship Examples: Who Might Benefit From This Business Structure?

The following types of business owners benefit most from a sole proprietorship:

• Those who prefer small businesses
• Those who conduct low-risk businesses
• Those who don’t plan to expand their business

Some businesses start out as sole proprietorships but later restructure due to business growth and expansion.

For example, Carmen Santiago starts her business, Carmen’s House of Beauty, selling soaps and fragrances she makes in a small shed behind her home. Eventually, Carmen secures a manufacturing facility, and her products get picked up by large, big-box retailers that now sell them in thousands of stores across the country.

Eventually, Carmen realizes she wants to grow even bigger. To attract investors and make it easier to get a business loan, she decides to restructure her business as a corporation, which requires her to file paperwork and engage in ongoing administrative and legal maintenance at the state and federal levels.

In contrast, some sole proprietorship owners do not wish to grow and expand their business, preferring to run it as a small entity.

For example, Coach Louie, a former P.E. teacher turned personal trainer, travels to clients in his hometown to help them improve their fitness. Louie doesn’t want to travel outside the boundaries of his local jurisdiction. He simply runs his sole proprietorship under the name Louie Loves Fitness and purchases liability insurance to cover himself in case of an accident.

If Louie desires to expand the business, he can always offer classes online, but he may never need to restructure the business if he doesn’t plan to significantly alter the business model.

Advantages of Sole Proprietorships

A sole proprietorship offers several advantages to business owners who use it:

• Minimal paperwork, even for those using a trade name
• Easy maintenance with no ongoing state requirements
• No need to file a separate business tax return with the IRS
• Total control since you are the only one responsible for the business

These advantages are why some consider sole proprietorships the simplest type of business to start.

Drawbacks to Sole Proprietorships

Though sole proprietorships have many advantages, they are not without drawbacks:

• The owner is personally liable for all debts and legal issues.
• Investors may be hesitant because there are no stocks to offer.
• Banks may be wary of lending to sole proprietorships due to personal liability issues.
• The business cannot survive if the owner dies or becomes incapacitated.
• Sole proprietors do not have support from partners since there is only one owner.

Only you can decide what type of business entity is right for you based on your financial needs and administrative preferences.

A Comparison of Business Entity Types

If you’re wondering whether a sole proprietorship is right for you, it may be helpful to compare entity types before you make a final decision. This table will help you compare a sole proprietorship vs. LLC or another type of entity you may be considering.