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.

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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:

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:

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:

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.

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Advantages of Sole Proprietorships

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

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:

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.

Entity Type
Formation
Maintenance
Taxation
Liability
Sole Proprietorship
No filing needed unless a DBA is necessary
No ongoing state filings or fees
Pass-through; reports income and losses on personal income taxes
The owner is personally liable for business debts and legal issues.
General Partnership
No registration needed unless a DBA is necessary
No ongoing state filings or fees
Pass-through; each partner pays tax and reports losses on their share of the income on personal income taxes
Partners are personally liable for business debts and legal issues.
Limited Partnership
One general partner and 1+ limited partners must register with the state
Ongoing state filings and fees required

Pass-through; each partner pays tax and reports losses on their share of the income on personal income taxes.

A separate tax return for the partnership is required.

The general partner assumes all financial liability. Limited partners have limited personal liability if they don’t manage the company.
Limited Liability Company
Must register with the state
Ongoing state filings and fees required

Pass-through; each owner pays tax and reports losses on their share of the income on their personal income taxes.

LLCs may elect to be taxed as a corporation.

Owners are not usually personally liable for debts or legal issues.
Professional Limited Liability Company
At least half of the group's members must be licensed by the state in the same profession, and the company must register with the state. Some states require all members to be licensed.
Ongoing state filings and fees required
Single-member PLLCs are treated as disregarded entities, while multi-member PLLCs are taxed as a partnership.
Members are liable for their own malpractice but not the malpractice of other members.
Professional Corporation
At least half of the group's members must be licensed by the state in the same profession, and the company must register with the state. Some states require all members to be licensed.
Ongoing state filings and fees required
Taxed as a corporation. A separate tax return is required.
Members are liable for their own malpractice but not the malpractice of other members.
C-Corporation
Must register with the state
Ongoing state filings and fees required
Taxed as a corporation once income is offset with deductions, credits, and losses. Corporations pay shareholders using after-tax income. A separate tax return is required.
Shareholders are not usually personally liable for debts or legal issues.
S-Corporation
Must register as a formal business and then elect to be taxed as an S-corp
Ongoing state filings and fees required
Pass-through; each owner or shareholder pays tax and reports losses on their share of the income on personal income taxes.
Shareholders are not usually personally liable for debts or legal issues.
Nonprofit Corporation
Must register with the state
Ongoing state filings and fees required
Taxed as a corporation unless granted tax-exempt status as a 501(c)(3) organization
Owners are not usually personally liable for debts or legal issues.

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