Sole proprietorships are the most common type of small business in the United States because they are the simplest structure for business owners looking to start and operate a business. If you own a sole proprietorship, you own 100% of the business, but you are personally responsible for its debts and legal obligations.
While forming a sole proprietorship may seem relatively easy, sole proprietors still have significant responsibility to keep their business financially and legally sound.
What is a sole proprietorship and who is a sole proprietor?
A sole proprietorship is an unincorporated business structure with a single owner — the “sole proprietor.” Unlike a limited liability company (LLC) or corporation, there is no legal separation between the owner and the business. The defining characteristics of a sole proprietorship are:
- Ownership by a single, self-employed individual.
- No corporate entity exists (no incorporation).
- The owner is an extension of the business.
- The owner is responsible for any business assets and liabilities.
If you conduct business on your own and haven’t taken any formal steps to form a partnership or incorporate your business, you automatically have a sole proprietorship. Unlike other business structures, you don’t need a formal state filing, though you may still need a business license or trade name registration.
As an individual proprietor, your personal assets are tied to your business. Because the business and owner are legally the same, you’re personally responsible for all business debts and legal obligations. This simplicity makes sole proprietorships easy to establish, but it can also put your personal assets at risk.
Sole proprietorship vs. LLC: What is the difference?
Is an LLC a sole proprietorship? No: They’re different business structures with different liability protections and formation requirements.
The biggest difference is personal liability. A sole proprietorship has no legal separation between the owner and the business, while an LLC creates a separate legal entity that generally protects the owner’s personal assets from business liabilities.
Sole proprietorship | Single-member LLC | |
|---|---|---|
Legal structure | Owner and business are one legal entity | Owner and business are separate legal entities |
Liability | Owner is personally responsible | Generally limited to the LLC |
Formation | Automatic; no formation filing | State registration required |
Taxes | Generally reported on owner’s personal return | Same by default, unless another tax treatment is elected |
Administration | Fewer formalities | State filings and ongoing requirements |
If you started your business as a sole proprietorship, switching to an LLC may make sense when you take on more business risk, add owners, or want to protect your personal assets. Keep in mind that an LLC doesn’t automatically reduce your taxes or eliminate personal liability in every situation.
Advantages and disadvantages of a sole proprietorship
A sole proprietorship gives you direct control over your business without the formalities of forming a separate company. However, that simplicity comes with financial and legal trade-offs.
Advantages | Disadvantages |
|---|---|
Simple setup with minimal formation costs | Unlimited personal liability for business obligations |
Complete control over business decisions and profits | Business continuity depends heavily on the owner |
Business income is generally reported on your personal tax return | Self-employment taxes may apply |
Fewer ongoing administrative requirements | Cannot issue stock to raise investment capital |
Flexibility to change operations as the business grows | Financing may depend heavily on personal credit and income |
Personal liability is especially important if you’re considering a sole proprietorship. If the business faces a lawsuit or cannot satisfy its debts, creditors may pursue your personal assets. Business insurance can cover certain risks, but it doesn’t provide the legal separation an LLC offers.
How are sole proprietorships taxed?
Sole proprietorships generally use “pass-through taxation”: Business profits and losses are reported on the owner’s individual federal income tax return rather than a separate corporate return.
Owners typically file Schedule C (Form 1040) to report business income and deductible expenses. When net earnings reach $400, owners also need to file Schedule SE (Form 1040) to report self-employment income.
Because taxes aren’t automatically withheld, sole proprietors may need to make quarterly estimated tax payments. These generally apply when you expect to owe at least $1,000 in federal tax after withholding and credits, subject to additional IRS rules.
Qualified deductions are subject to the IRS; state taxes for sole proprietorships vary. Understanding the roles of a bookkeeper vs. an accountant can help you decide what financial support your business needs.
Learn more about sole proprietorship taxes.
How to start a sole proprietorship
With a sole proprietorship, starting the company may actually be the easiest part of owning the business. With few legal requirements (depending on the industry) and low expenses, it can be as simple as choosing an idea and executing it. Here’s a brief guide to starting your own sole proprietorship.
1. Decide on a business idea
Before you start a small business, decide what service or product you’ll offer and whether you want to operate under your own name or a “doing business as” (DBA) name. Make sure you have a small business plan before starting the administrative tasks of launching a business.
2. Research local laws and license requirements
While sole proprietorships have fewer requirements, you may still need a local business license to operate, and potentially state or federal licenses if you operate in a regulated industry. A common example is getting a liquor license if you open a restaurant or bar that serves alcohol.
3. Start selling your service or product
The final step is to start doing business. Sole proprietorships are quick and easy, so as soon as you have the necessary licenses, you can put your service or product on the market. Once you start selling your services, you’ll have additional considerations, like how you’ll handle accounting and pay quarterly taxes. It may be wise to consult another business owner in your area for advice.
Sole proprietorships let anyone open their own business, with complete ownership and responsibility for their successes and failures. However, remember that starting and running a business can be as hard and stressful as it is rewarding. Even if a sole proprietorship is the right business structure for you, surrounding yourself with supportive business owners and using free resources from the SBA or local business centers can help you operate and grow your business.
Can a sole proprietor get business financing?
Yes. Sole proprietors can qualify for business loans and other financing, but approval depends on the provider and the business’s financial health.
Financing providers typically review personal credit, time in business, revenue, bank deposits, and existing debt. Because the business isn’t legally separate from its owner, personal credit and liability can carry greater weight, and the agreement may require a personal guarantee. Keeping separate bank records helps lenders evaluate your business cash flow and ability to make payments.
Credibly looks at a wide range of factors to assess your business’s overall performance, not just your credit history. For instance, minimum eligibility requirements for a Credibly Working Capital Loan* generally include at least 6 months in operation, $20,000 in average monthly deposits, and a 550+ FICO score. If you’re a newer sole proprietor, consider exploring startup business financing while you build your revenue history.
Learn more about what lenders review beyond a credit score.
Frequently asked questions
Do I need an EIN as a sole proprietor?
Not always. An Employer Identification Number (EIN) is generally required when you hire employees, set up a retirement plan, or meet certain other IRS requirements. Sole proprietors without employees can typically use their Social Security number for tax purposes.
Should a sole proprietor use a separate business bank account?
Yes. A separate account simplifies bookkeeping and tax preparation, and can help you show business revenue when applying for financing. A separate account can also support your efforts to build business credit, although building credit generally requires additional steps.
Can a sole proprietor hire employees?
Yes. Sole proprietors can hire employees but must meet payroll, withholding, and employment tax requirements.
Can two people own a sole proprietorship?
No. A sole proprietorship has one owner. Two people operating a business together generally need another structure, such as a partnership or LLC.
Is a DBA the same thing as a sole proprietorship?
No. A DBA (“doing business as”) is a registered alias that lets you operate under a name different from your legal name. It doesn’t create a separate legal entity.
Can a sole proprietor have more than one DBA or business activity?
Yes. A sole proprietor can typically operate multiple activities or DBAs, subject to state and IRS laws.
Does a sole proprietor need business insurance?
Not necessarily, but it can be smart if your business involves a risk of property damage or liability claims. Since there is no separation between the business’s assets and your own, insurance coverage can offer some protection.
Can a sole proprietor sell or transfer the business?
Yes. A sole proprietor can sell business assets and transfer eligible contracts, but the sole proprietorship itself isn’t a separate legal entity that can be sold.
Can a sole proprietor bring in an investor without changing the business structure?
You can obtain financing, but giving an investor an ownership stake requires a different business structure.
What records should a sole proprietor keep separate from personal finances?
Keep business income, expenses, receipts, invoices, bank transactions, payroll records, and financing documents separate from your personal records. Maintaining a profit and loss statement can also help you track business income, expenses, and profitability.
*Credibly merchant cash advances and working capital loans to merchants in California are provided by Retail Capital LLC. All other Credibly products in all other jurisdictions are provided by Credibly of Arizona LLC.
