What is a Sole Proprietorship?
A sole proprietorship is an unincorporated business. Legally speaking, there is no distinction between a sole proprietor and their business. You become a sole proprietor simply by conducting business.
Profit and loss are reported on the sole proprietor's tax return, and the business owner is personally liable for all debt and risk.
Sole proprietorships are useful for small businesses with the following traits:
- They MUST be low-profit and low-risk (low chance of liability or financial loss).
- They have a smaller customer base — usually friends, family, and neighbors.
- They sometimes start as hobbies like blogging, photography, or video streaming.
Sole Proprietorship Examples
Any low-profit/low-risk business operated by one person can be a sole proprietorship.
For example, tutors, artists, counselors, and musicians are all professions that could potentially run as sole proprietorships.
Running a Sole Proprietorship
If you'd like to operate a sole proprietorship using any name other than your given name, you'll need to get a "doing business as" (DBA) name. This will allow you to use an assumed name for branding and banking purposes.
EINs and Hiring Employees
Sole proprietorships are usually one-person businesses, but they can hire employees if the owner obtains an Employer Identification Number (EIN).
Sole Proprietorship Taxes
A sole proprietorship isn't a legally distinct business entity — your business income as an owner is included on your personal tax return. Remember that as a sole proprietor, you're technically self-employed, so you'll need to pay income tax and self-employment tax each year.
Advantages and Disadvantages of Being a Sole Proprietor
There are times when operating a sole proprietorship makes sense versus a legal business structure like an LLC or a corporation.
A sole proprietorship is only safe for business owner that is doing business on a small scale or who want to try out a low-risk venture to see how successful it will be.
Sole proprietorship Advantages:
Sole proprietorships offer one advantage—they don't require any formal filing requirements or fees to get started. While this might be appealing to many business owners, there is a catch—sole proprietors don't have any personal asset protection if the business suffers a loss.
This means a sole proprietor's house, car, or personal savings could be lost if the business suffers a loss (either by creditors or lawsuits).
Sole Proprietor Disadvantages:
- Zero Personal Liability Protection. Your personal assets (car, house, bank account) could be at risk in the event your business suffers a loss.
- Zero Tax Benefits. Sole proprietors pay taxes on their profits and also pay full FICA taxes (Medicaid and Social Security taxes). When your business becomes profitable, taxes will become expensive.
- Limited Growth Potential. When a business becomes more profitable, risk increases. When risk and profit increase, so does the need for a legal formal business structure.
- Reduced Credibility and Branding Opportunities. A sole proprietor must invoice, receive payment, open a bank account, and market with their surname unless their state allows them to register and maintain a doing business as (DBA) name.
You can avoid these issues by forming a limited liability company (LLC). An LLC is a simple and inexpensive business structure to form, and it provides personal asset protection.