What is a Sole Proprietorship?

Sole Proprietorship Definition: A sole proprietorship is an informal, unincorporated business entity that isn’t legally separated from its owner. Profit and losses are reported on the individual’s tax return and the business owner is personally liable for all debt and risk.

Sole proprietorships are best for small businesses with the following characteristics:

  • They MUST be low-profit and low-risk (low chance of liability or financial loss).
  • They have a smaller customer base — often friends, family, and neighbors.
  • They sometimes start as hobbies like photography, blogging, or video streaming.

diagram showing the benefits of informal business structures

Sole Proprietorship Examples

Any low-profit/low-risk business that could be operated by one person could be a sole proprietorship.

For example, artists, counselors, freelancers, independent contractors, tutors, and musicians are all professions that could potentially be ran as sole proprietorships.

Doing Business as a Sole Proprietorship

Because a sole proprietorship isn't a separate legal entity, the owner typically signs checks, contracts, and lease agreements in his or her own name. Likewise, payments made to a sole proprietorship are made out to the owner’s name.

If you operate a sole proprietorship and wish to conduct business under an assumed name, you can register a “doing business as” name (DBA) for your company. With a DBA, you can even open a business bank account and receive payments under your fictitious name.

Employees and EINs

Although sole proprietorships are usually one-person businesses, they can hire employees if the owner obtains an Employer Identification Number (EIN).

Sole Proprietorship Taxes

Because 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 both income tax and self-employment tax each year.

What are the Advantages and Disadvantages of Sole Proprietorship?

Under certain circumstances, sole proprietorships offer small advantages and benefits over formal business structures (like LLCs and corporations).

Example: A sole proprietorship can be a good way to start out if you are doing business on a small scale or want to try out a low-risk venture to see how successful it will be.

Sole Proprietorship Advantages:

The only advantage to starting a sole proprietorship vs. an LLC is having to spend no money or energy upfront to form a business. This advantage may seem attractive, but it can be costly in the long run.

Sole Proprietorship Disadvantages:

  • No Personal Liability Protection. Your personal assets (car, house, bank account) are at risk in the event your business is sued or if it defaults on a debt.
  • No 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 be 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.
  • Less 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.

To avoid these issues, you can form a limited liability company (LLC). An LLC offers many of the same advantages of a sole proprietorship, while also providing asset protection.

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Form An LLC

Recommended: Protect your personal assets by forming an LLC for your small business.

When Should a Sole Proprietorship Become an LLC?

It is time to go from a sole proprietorship to an LLC when you are serious about growing your business and earning a profit.

Sole proprietorships are only good for very low-profit/low-risk businesses. 

Example: A sole proprietorship can be a good way to start out if you are doing business on a small scale or want to try out a low-risk venture to see how successful it will be.

Forming an LLC allows business owners to grow their businesses and take on risk. This is because LLCs provide personal liability protection.

What is personal liability protection? When a business owner has personal liability protection, they can’t be held personally responsible if the business suffers a loss. This means personal assets (car, house, and bank account) are protected.

Why You Should Form an LLC

There are several benefits to starting an LLC that may or may not matter to a business owner.  But, regardless of any other factor, a business owner needs to form an LLC when they start to earn a profit or carry risk.

This is because profit and risk open the door to liability. A sole proprietor's personal assets are completely exposed to creditors and lawsuits because legally, the sole proprietor is the business. In an LLC, the business can be legally separate from the business owner. 

By changing your business from a sole proprietor to LLC you will:

  • Protect your savings, car, and house
  • Increase your peace of mind
  • Protect your privacy
  • Increase business growth
  • Allow for greater profit
  • Allow for accelerated growth
  • Increase credibility

Ready to form an LLC? Use our Form an LLC guide to get started. Follow this link and then choose your state for step-by-step instructions.

Start An LLC