You have a business idea, and you're ready to make it a reality. Maybe you're freelancing, selling a product, or turning a side gig into something bigger. Now you need to figure out how to set your business up properly, without drowning in paperwork or getting hit with surprise fees.
Good news. A sole proprietorship might be the easiest place to start. It's the simplest and most common business structure available in the United States, and according to the SBA, it's also the least expensive to establish. For many first-time founders, a sole proprietorship is the natural first step.
In this article, we'll walk through what a sole proprietorship is, how it works, and how to start one. We'll also cover the advantages and disadvantages of a sole proprietorship, plus how it compares to an LLC, so you can decide with confidence whether it's the right fit for you and your business.
What is a sole proprietorship and who is it for?
A sole proprietorship is a non-registered, unincorporated business run by one individual, with no legal distinction between the business and the owner. As a sole proprietor, you are entitled to all the profits, but you're also responsible for the business's debts, losses, and liabilities.
It helps to know the difference between an owner and a sole proprietor. An owner can be a person or a legal entity, such as a corporation that owns one or more companies. A sole proprietor is specifically the individual who owns a business run as a sole proprietorship.
How does a sole proprietorship work for taxes?
In a sole proprietorship, profits, taxes, and liability flow straight to you. There's no separate business tax return when filing with the IRS. Instead, any profit you make is simply treated as your own personal income.
Two tax details worth remembering:
- You're taxed on all the profits of your business, whether you withdraw the money or not.
- You'll file a Schedule C for your profits and losses and a Schedule SE for self-employment taxes. Both are filed with your personal 1040 return.
Do you need to register a sole proprietorship?
Here's the part that surprises a lot of people: you don't need to formally register a sole proprietorship in order to create one. If you're the only owner and you start conducting business, you automatically become a sole proprietor. There's no paperwork to file at the federal, state, or local level just to be recognized as one.
However, forming the business and being compliant are two different things. Depending on your location and industry, you may still need to register with the state’s tax agency, get a business license, or obtain specific permits before you can legally operate.
What are the steps to starting a sole proprietorship?
While the business itself forms automatically, a few practical steps will help you start your sole proprietorship on solid ground:
- Confirm your business idea and name. Decide what you're offering and what you'll call your business.
- File a DBA if needed. Register a "doing business as" name if you’re not using your own legal name.
- Get an EIN if required. You'll need one if you’re hiring employees or filing certain tax returns.
- Check licensing and registration requirements. If applicable, register with your state's tax agency for things like sales tax or employer withholding. Then check with your city or county clerk to find out what local licenses and permits your business and location require.
- Set up your finances and insurance. Open a separate business bank account, determine how you will track income and expenses, and consider liability insurance.
Does a sole proprietorship need a DBA or EIN?
If your business will operate under a name other than your own, most areas require you to register a DBA, or "doing business as," name. This tells the public and local government who owns the business.
Alternatively, you can skip the DBA and simply operate under your own legal name. This can work well for marketing, especially if you’re building a personal brand. But keep in mind that any trouble the business runs into will carry your name, too.
You must obtain an EIN, also known as a Federal Employer Identification Number, if you plan to have employees, file excise tax returns, or file pension plan tax returns. Otherwise, the IRS generally lets you use your Social Security number as a sole proprietor. You can apply for an EIN online or by filing IRS Form SS-4.
What are the advantages of a sole proprietorship?
A sole proprietorship is appealing because it's simple and inexpensive. Here are the key advantages:
- Easy startup: There's no formal registration to create the business, and startup costs are typically low.
- Taxes: There's no separate business tax filing. Your profits are treated as personal income.
- Maintenance: Ongoing requirements are minimal compared to other business structures, with low legal and administrative costs to keep things running.
- Control: You have complete decision-making power. With no partners, you run things exactly as you choose.
Disadvantages of a sole proprietorship
Before you commit to starting a sole proprietorship, weigh these potential drawbacks against the benefits:
- Liability: You're personally liable for all business obligations. Creditors can pursue your personal assets, like your savings or home, to cover business debts. (Business insurance can help reduce this risk.)
- Funding: Raising money is harder because you can't sell stock, and banks may hesitate to approve a business loan without a business credit history or separate business assets to secure the loan.
- Long-term survival: A sole proprietorship rarely survives if the owner dies or is incapacitated, since the business and owner are legally one and the same.
- Lack of support: You alone are responsible for every decision, with no partners or co-owners to share the workload, offer guidance, or step in when you need help.
Sole proprietorship vs. LLC: which is better?
The core difference between a sole proprietorship and an LLC comes down to personal liability protection. A sole proprietorship offers none, since there's no separation between you and the business. An LLC is a separate legal entity, which generally shields your personal assets from business debts.
Choose a sole proprietorship if you're a freelancer or running a low-risk side gig and want a fast, low-cost start. Consider an LLC or corporation if you need funding, plan to grow quickly, or want liability protection. For a closer look, see single-member LLC vs. sole proprietorship.
When does a sole proprietorship make sense?
A sole proprietorship makes sense when you're testing an idea, freelancing, or running a low-risk business by yourself. It's quick, affordable, and easy to maintain.
This business structure makes less sense when your business carries real liability risk, needs outside investment, or is poised for fast growth. In those cases, a more protective structure is usually the smarter choice.
Common questions about sole proprietorships
Is a sole proprietorship free to start?
Mostly, yes. The business is created automatically with no formation fee. You may still have to pay for a DBA, licenses, or permits depending on your location and industry.
Do I need an EIN for a sole proprietorship?
Only if you hire employees or file certain tax returns. Otherwise, you can usually use your Social Security number.
Can I convert a sole proprietorship to an LLC later?
Yes. Many founders start as a sole proprietor and form an LLC once their business grows or needs liability protection.
Am I personally liable for business debts?
Yes. In a sole proprietorship, there's no legal separation between you and the business. Your personal assets, like your savings or home, can be used to cover business debts.
Take your next step with confidence today
A sole proprietorship gives you the easiest, lowest-cost way to start a business. The tradeoff is simple: easy setup, but no personal liability protection. Knowing that trade-off helps you choose the right structure from the start.
Not sure which structure fits your goals? Compare sole proprietorship, LLC, and corporation options with our business type comparison chart, then start your business with guided help from the experts at BizFilings.