What Is A Sole Proprietorship? The Complete Small Business Guide
If you've ever considered opening a business by yourself, our guide on how to start a sole proprietorship has the answers you're looking for.
Sole proprietorships are one of the most common business structures for small businesses with just one owner. They’re easy, efficient, and cost-friendly. But before deciding on becoming a sole proprietor, it’s important to understand what is a sole proprietorship, its benefits, and its drawbacks.
We hope to make the process easier by breaking down exactly what to expect as a sole proprietor running a small business. Keep reading to find out more.
Table of Contents
- The Definition of “Sole Proprietorship”
- Examples Of Sole Proprietorship Businesses
- Should I Use A Sole Proprietorship For My Business?
- Sole Proprietorships VS Other Business Structures
- How To Start A Sole Proprietorship
- Can You Get A Business Bank Account With A Sole Proprietorship?
- Do You Need Business Insurance For A Sole Proprietorship?
- Do You Need To Register A Sole Proprietorship Business?
- A Sole Proprietorship Is The Default Option, But Not Your Only One
- FAQs: Sole Proprietorships As A Small Business Option
The Definition of “Sole Proprietorship”
To start things off, what’s a good sole proprietorship definition? In the words of the IRS, a sole proprietor is “someone who owns an unincorporated business by himself or herself.” In plainer terms — a single person owns the business, and there’s no legal distinction between the owner’s personal and business-related property.
It’s important to note here that a sole proprietorship is not a separate legal entity. This means the owner is solely responsible for the business’s debts, obligations, and liabilities. Your personal assets may be seized to fulfill debts, and lawsuits can be brought against you personally.
Examples Of Sole Proprietorship Businesses
Realistically, there’s no limit to the kinds of businesses than can be sole proprietorships. So long as a good or service is being sold and there’s only one business owner, it’s set up to go. To get a sense of the breadth of possibilities, consider these examples:
- Home healthcare providers
- Food and beverage caterers
- Housekeeping services
- Virtual assistants
- Freelance writers, editors, or designers
- Computer repair technicians
- Spiritual guides
- Arts and crafts designers
- Dog walking services
- Financial advisors
- Web and marketing consultants
- Lifestyle coaches
All of these can be structured as sole proprietorships.
Looking Closer At Sole Proprietorship Examples
Here are some hypothetical sole proprietorship examples to give you a better picture of what sole proprietors do and the kind of business decisions they make.
Spencer is a carpenter whose side gig is selling custom-made wooden crafts and the like through an online storefront. He works on the projects he’s commissioned for entirely at home, and he recently spent a pretty penny on new equipment and tools to raise the quality of his products. This is a business expense he’s planning to utilize as a tax write-off, but since he’s a sole proprietor, that property is legally his own. Since his day-to-day operations and products are relatively low-risk, he does not currently plan on pursuing incorporation and registering his business as a separate legal entity.
Rose is a spiritual guide who uses astrology, tarot, and her deep intuition to provide her clients with advice on a large variety of topics — romance, careers, lifestyle, you name it. She makes enough money to rent office space close to her home and has no employees. She applied for a DBA through her state and purchased professional liability insurance since she didn’t want to risk being taken to court on the grounds that her advice ended up harming someone. She’s happy with how her business is currently structured and doesn’t intend to expand, so she’s choosing to remain the only owner and continue operating as a sole proprietor.
Emilio is an established SEO that helps local small businesses boost their organic web traffic and provides digital marketing consultations as a plus. He can work anywhere with a stable internet connection and occasionally visits his clients at their places of business. He also received an EIN through the IRS so that he could hire an employee to assist with scheduling and emails. Business has been going great — his clients are consistently thrilled with his results, and he’s been earning plenty of referrals. Forming an LLC is a thought he’s had since he has plenty of room to grow his business. But right now, he doesn’t need the extra layer of liability protection since it’s just him as the sole owner and his assistant. In fact, after withholding all the relevant taxes for his employee, he’s netting more revenue as a sole proprietor since he doesn’t have to pay income tax to the state he does business in.
Should I Use A Sole Proprietorship For My Business?
With the definition and some examples under your belt, you should have at least some idea of why business owners would choose this structure. Now, let’s go over the benefits of operating your business as a sole proprietor.
Advantages Of Sole Proprietorships
- Less Expensive: Sole proprietorships are the easiest and least expensive business structure. This is ideal for business owners that aim to keep their startup costs as low as possible.
- No Registration Required: Sole proprietors simply need to participate in business activities to exist. No state registration is required. However, applicable permits and licenses will need to be obtained to operate in your state legally.
- No Ongoing Requirements: Sole proprietors are not required to hold meetings, record meeting minutes, or have a board of directors.
- Full Control Of The Business: As a sole proprietor, there are no additional owners or shareholders to consider. You get to make all business decisions, and you receive all of the profits.
- Easier Tax Returns: Sole proprietors can file their business profits, losses, and expenses on their personal tax returns with just two additional forms.
Disadvantages Of Sole Proprietorships
While being a sole proprietor definitely comes with benefits, there are also drawbacks to consider when weighing your decision. Those drawbacks include the following:
- No Liability Protection: As a sole proprietor, you will be held responsible for the debts, obligations, and liabilities of your business. If you default on a loan, lenders can come after your personal assets, such as your bank account, vehicle, or real estate. If your business goes bankrupt, your personal finances could be affected. Finally, lawsuits can be filed against you personally, which would also put your assets at risk.
- Financing Challenges: As a sole proprietor, getting business financing can be challenging. Most lenders — from traditional lenders like banks to online alternative lenders — only provide financing to registered entities. Sole proprietors also can’t sell stock in the business as a way to raise capital. As a sole proprietor, you may have to get more creative with your financing, such as launching a crowdfunding campaign or taking out a personal loan for business.
- Tax Complications: All sole proprietors are considered self-employed, so they must pay a self-employment tax equivalent to 15.3% of their income (12.4% for Social Security and 2.9% for Medicare). Depending on your state, you may also need to pay state income tax in addition to federal taxes. Lastly, if you have employees, you’ll need to accurately and compliantly withhold a portion of their earnings to pay their income tax, which varies from state to state. You must report what you’ve withheld every quarter to the IRS.
A Sole Proprietorship Is Best For…
A sole proprietorship is best for businesses that don’t need complicated requirements, protections, and expenses to start up and maintain. The simpler your business, and the more it benefits from a single owner with full control, the better it is to remain a sole proprietor.
In general, the kinds of businesses that are best suited for sole proprietorships are:
- Low-Risk Businesses: A sole proprietorship will benefit you in the long run if the chances of you getting sued for, say, malpractice or physical harm are slim to none.
- Low-Income Businesses: Lower income isn’t necessarily a bad thing — maybe your business is a creative way to earn extra money. If you sell handmade scarves and socks on Etsy or Shopify, for instance, you’ll likely be taking home more cash if you opt to remain as a sole proprietor.
- Home-Based Businesses: Say you’ve converted your garage into a workout studio or hair salon. A sole proprietorship might be the best way to structure your business in this case.
Sole Proprietorships VS Other Business Structures
Sole Proprietorship VS Partnership
The biggest difference between a sole proprietorship and a partnership is the number of owners of the business. A sole proprietorship has a single owner. A partnership has two or more owners. Each partner must accurately and compliantly file their taxes according to the income they’ve accrued through the business.
Besides that, a sole proprietorship and a partnership are very similar:
- Neither has to be registered with the state
- Profits and losses are filed on personal tax returns for both
Sole Proprietorship VS LLC
A limited liability company, or LLC, combines the benefits of different business entities. In contrast to sole proprietorships, LLCs have liability protections in place to protect the owners’ personal assets. LLCs may also have multiple owners, whereas a sole proprietorship is limited to a single owner.
Other important differences are that:
- An LLC must register with the state
- Starting an LLC incurs fees, whereas sole proprietorships do not
- Owners of an LLC can choose how they are taxed — they may opt to have their profits taxed as personal income, as with a sole proprietorship, or as corporate earnings
Sole Proprietorship VS Corporation
Sole proprietorships and corporations are quite different. A corporation is the most expensive business entity to form and must be registered with the state. There are also multiple ongoing requirements corporations must meet that sole proprietors don’t, such as holding meetings and having a board of directors.
Altogether, these are the biggest differences to look out for:
- Corporations may have multiple owners, whereas a sole proprietorship has just one owner
- Corporations can also raise capital through the sale of stock, which a sole proprietor can’t do
- Corporations offer the best personal liability protection for their owners
- Corporations must pay separate income taxes — if dividends are paid to shareholders, shareholders must report this on their personal tax returns, resulting in double taxation for the corporation
How To Start A Sole Proprietorship
A sole proprietorship is the quickest, easiest, and most inexpensive way to start and operate a new business. Unlike the above-mentioned business entities, which require registration and periodic fees, simply engaging in business activities legally establishes a sole proprietorship.
Depending on the kind of business you choose to run, though, additional steps may be involved before you can open up shop. Here are the most basic ways you can get things started:
- Decide What You’re Going To Sell: This part is crucial! Knowing in advance what you plan to sell will help you prepare for any risks, liabilities, and extra expenses.
- Apply For A DBA: Your business’s name is automatically your legal name if you’re a sole proprietor. A DBA, which stands for “doing business as,” is a great way to create a stronger business identity without registering it as a separate legal entity.
- Get An Employer Identification Number (EIN): Having an EIN for your sole proprietorship comes with several benefits. Not only will you be able to hire employees legally, but it will also help prevent identity theft and establish business credit. You can easily apply through the IRS for free.
- Acquire Any Necessary Licenses, Certifications, & Permits: This really comes down to the requirements for your industry set by your city, county, and state. Check your local government portals to make sure your business is compliant — don’t risk any fines.
Bear in mind that once you start a sole proprietorship, you aren’t stuck with having that as your business structure. If an LLC, partnership, or corporation best suits your projected growth and business operations, you can transition to one of those when the time comes.
Can You Get A Business Bank Account With A Sole Proprietorship?
It’s possible to get a business bank account with a sole proprietorship. The SBA recommends that you have your Social Security Number and business formation documents ready, but check to see if the bank you want to open an account through requires an EIN or any other kind of business information.
You may be tempted to handle your business financials with your personal bank account, but in the long run, it’s a better idea to keep the two separate:
- A business bank account will help you keep your personal and business-related finances separate, which is immensely helpful for record-keeping and if you happen to get audited.
- It will be far easier to apply for small business loans over time since having a business bank account allows you to build your business credit (such as through a business credit card).
Check out our guide on the best small business bank accounts. When you’re ready, we’ve also covered everything you need to set up a business bank account.
Do You Need Business Insurance For A Sole Proprietorship?
The answer to this is a clear, resounding yes. Sole proprietors are especially susceptible to legal and financial woes since there is no distinction between their personal and business assets — if things go south, you could lose your car, your personal savings, or even your home.
At the bare minimum, the kinds of business insurance coverages you should consider are:
- General Liability Insurance: This is the foundation for all other kinds of insurance. If you run advertisements, or if there’s a chance a customer could get hurt at your place of business, general liability insurance will cover the legal and medical costs associated with the accident or mishap.
- Professional Liability Insurance: Businesses that earn income by providing specialized services ought to look into a professional liability plan. Say you’re a sole proprietor who charges for financial advice — if a client sustains financial harm from following your advice, professional liability insurance can help protect you.
- Commercial Auto Insurance: If you use your car for business-related purposes, you may be responsible for purchasing a commercial auto policy in some states (such as Florida).
Do You Need To Register A Sole Proprietorship Business?
You won’t be required to register your sole proprietorship in any of the 50 states. You can use your Social Security information when filing your taxes since the IRS does not distinguish between your business and personal financials.
However, there are some caveats. Always check with your city and county to see if they require you to register your business with them. The majority of sole proprietorships will need a business license to be in compliance. Also, if what you sell is subject to a sales tax, you’ll need to acquire a seller’s permit through your state.
A Sole Proprietorship Is The Default Option, But Not Your Only One
For many aspiring business owners, operating a sole proprietorship is the right path to entrepreneurship. If you’re set on remaining a sole proprietor, consider applying for a DBA, open a business bank account, and definitely don’t skimp on business insurance — you’ll thank yourself when you need to use it!
But maybe a sole proprietorship isn’t your end-all, or you’re unsure if it’s the best path forward. Consider consulting with an accountant or attorney to help determine if a sole proprietorship will meet the needs and goals of your business. You can learn more about the different types of business structures to help you further pinpoint which option is best for you.
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