When you’re starting a business, you may opt to structure it as a sole proprietorship. A sole proprietorship is one of the simplest and easiest business entities to establish, which is why many consultants, contractors, and entrepreneurs decide to go this route.
Key Points
• Easy setup with minimal paperwork and complete control over business operations is a key advantage of sole proprietorships.
• Flexibility exists to convert to other business entities like LLCs or S corporations.
• There is unlimited personal liability for business debts and legal actions, risking personal assets.
• Obtaining business loans can be challenging due to perceived higher risk and limited business lifespan.
• Taxation is straightforward with pass-through taxation, but managing self-employment taxes and quarterly estimated payments is required.
What Is a Sole Proprietorship?
A sole proprietorship is a business run by just one person, as its name implies. Here, we take a look at this type of business entity to give you a clear picture of its pluses and minuses.
Definition and Basic Characteristics
A sole proprietorship is an unincorporated business that’s owned and operated by one individual.
If you’re the only member of a domestic limited liability company (LLC) and choose to treat it as a corporation — as many business owners do for tax purposes — the IRS does not consider you a sole proprietor.
Legal Status of Sole Proprietorships
Anyone who starts doing business without incorporating is considered a sole proprietor. Legally there is no separation between you and your business, so the company’s debts and assets are treated as your personal debts and assets.
In some states, sole proprietors in certain industries must apply for various business licenses or permits. You may also be required to register a name for your business.
Advantages of Sole Proprietorship
Sole proprietorships are popular for several reasons. First, it’s easy to set one up. Depending on your state, you may have a minimal amount of paperwork that’s easy to complete online, or you may not have to file anything at all. Also, being a sole proprietor gives you complete control of your company. There are no employees or supervisors to manage; it’s just you.
Finally, there’s the flexibility. You can convert your sole proprietorship into another type of business entity, such as an LLC or an S corporation, at any time. You can do this later as you acquire employees or find that your business needs have changed.
Disadvantages of Sole Proprietorship
Sole proprietorships have their downsides as well. As mentioned above, a sole proprietorship treats your business assets as personal assets, meaning you’re individually liable for any company losses. If your business were to lose a lawsuit, you yourself would be responsible for any damages. Getting small business loans can be more difficult for sole proprietors, as banks can consider these businesses to have a higher risk.
Furthermore, sole proprietors may find that having a one-person business can complicate their work-life balance. When your business is run by you and you alone, it may seem like you’re always at work.
Operating as a sole proprietorship also limits the business’s lifespan. When you retire, the business will cease to exist. You will be able to sell off the business’s assets, but not the business as a whole.
Sole Proprietorship vs. Other Business Structures
When planning your new business, also consider alternatives to a sole proprietorship. Each will have its pros and cons.
Limited Liability Company (LLC)
An LLC structure can protect owners’ personal assets from bankruptcy or lawsuits, unlike a sole proprietorship. Getting a business loan for an LLC is easier than getting one for a sole proprietorship. However, setting up and maintaining an LLC costs more, due to state fees and annual reports, and taxation rates and rules may differ.
Partnerships
If more than one person will own the new business, it’s automatically a general partnership (unless the owners opt to make it an LLC). Establishing and running a partnership is simple, but as with a sole proprietorship, owners have no financial protections; they are personally responsible for any losses or damages incurred by the business. An LLC can be equivalent to a partnership for tax purposes.
Corporations
A standard corporation — often called a C corporation — is its own entity, legally separate from its owners. This means that the corporation, not its owners, are held legally liable for damages. There are also tax considerations. The corporation pays tax on its profits, while its owners and employees also pay taxes on their earnings. An S corp is a distinct type of corporation that, like a sole proprietorship, avoids this type of double taxation.
Recommended: Sole Proprietorship vs LLC: How to Choose
Who Should Consider a Sole Proprietorship?
A sole proprietorship can be ideal for a small business owner without employees who wants to get a company up and running quickly. This structure can work well for small business owners who have very little exposure to legal liability. Examples would include freelance writers, artists or online product resellers.
Setting Up a Sole Proprietorship
With little or no paperwork involved, anyone can start a sole proprietorship in minutes and start charging for their products or services. Bookkeeping is often simple, with billing based on standard “Net 30” invoices.
Depending on your field and the state you’re doing business in, there may be no legal requirements at all to operate as a sole proprietor. Nevertheless, for certain industries — such as barbers, electricians, plumbers, and architects — you may be obligated to register or get a business license.
With a sole proprietorship, you can use your own legal name as the name of your business. You may wish to file DBA (“Doing Business As”) paperwork to register your business name. Depending on which state you’re in, this step may not be necessary, but it does help you establish a separate identity for your business.
For example, instead of operating a roofing business as just “Bob Smith,” you could call your company “The Roofing Guy,” “Tri-State Roofing,” or any other name that’s available.
Tax Implications for Sole Proprietors
Sole proprietors’ income is subject to pass-through taxation. This means that the business owner reports business income or losses on their personal tax return. With their annual IRS Form 1040, they must file a Schedule C, as well as a Schedule SE for self-employment tax used in calculating Social Security benefits.
In addition, each quarter sole proprietors must pay estimated taxes using Form 1040-ES.
Recommended: What Are the Tax Benefits of a Limited Liability Company (LLC)?
Growing and Evolving Beyond Sole Proprietorship
If your business outgrows its sole proprietorship status, you can easily convert it to another type of business. All you need to do is to file the appropriate documents for an LLC, partnership, or corporation. Nothing else is needed to dissolve the sole proprietorship.
You may also wish to file an IRS Form SS-4 to obtain an employer identification number (EIN). Like a Social Security number (SSN), an EIN is a nine-digit number that businesses use to identify themselves to the IRS for tax filing and reporting purposes. You may also use an EIN when applying for a small business credit card or for other banking purposes.
The Takeaway
A sole proprietorship is the easiest type of business to create. This type of business has both advantages and drawbacks, including tax and liability considerations. Understanding how a sole proprietorship differs from partnerships and various corporate entities will help you choose the best structure for your small business needs.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How do I register a sole proprietorship?
If you’re operating your sole proprietorship under your legal name, no registration is required. Otherwise, you may wish to register a DBA (“Doing Business As”) name. Depending on the nature of your business, your state may also require that you obtain a license.
Can a sole proprietorship have employees?
No. In a sole proprietorship, the owner is the company’s only employee. But a sole proprietor may hire independent contractors as needed.
What happens to a sole proprietorship when the owner dies?
When a sole proprietor dies, the business ceases to operate. The business’s assets and liabilities become part of the owner’s estate.
Photo credit: iStock/Rockaa
SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.
This content is provided for informational and educational purposes only and should not be construed as financial advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOSMB-Q424-018