What Is a Sole Proprietorship? Pros, Cons, and Compliance
A sole proprietorship is an unincorporated business owned and run by one person, with no legal separation between the owner and the business. It is the simplest and least expensive business structure to start. If you begin selling goods or services without forming an LLC, corporation, or partnership, you are already operating as a sole proprietor.
This article covers how a sole proprietorship works, its advantages and disadvantages, the filings a sole proprietor still owes, and when to consider forming an entity.
At a Glance
- You become a sole proprietor automatically when you start doing business on your own, with no state formation filing required.
- You’re personally responsible for your business’s debts, so your personal assets can be used to pay them.
- You may still need a DBA if you operate under a name other than your own, plus any required local licenses, and you owe self-employment tax on your business income.
- If you plan to take on more risk, bring in partners, or seek financing, consider forming an LLC or corporation. Doing so adds state requirements, such as annual reports and a registered agent.
How a Sole Proprietorship Works
A sole proprietorship has no formation filing and no state approval to wait on. Because the business has no legal identity apart from you, you carry its debts and legal obligations personally, and there is no limited liability protection for your home, car, savings, or other personal assets.
Many sole proprietors do business under their own legal name, so the owner’s name and the business name are the same. You can also operate under a brand or trade name by registering a DBA.
A business co-owned by a married couple is generally treated as a partnership for federal tax purposes. If both spouses materially participate in the business and file a joint return, they can elect to be treated as a qualified joint venture, with each spouse reporting their share on a separate Schedule C.
How to Start a Sole Proprietorship
If you operate under your own legal name, you generally don’t need to register anything with the state. Before you start doing business, check these requirements:
- DBA registration: To operate under a different name, most states or counties require you to file a DBA, or “doing business as,” registration first.
- Business licenses and permits: Your city, county, or industry may require a general business license or permit, whatever your business structure.
- Seller’s permit: If you sell taxable goods, you need a seller’s permit, separate from a general business license, to collect and remit sales tax.
None of these filings creates a separate legal entity. They register your sole proprietorship under the name you use and for the activities you conduct.
Advantages of a Sole Proprietorship
- Fast, low-cost setup: There’s no state filing, no formation fee, and no waiting period, so you can start invoicing clients as soon as you decide to.
- Simple taxes: Business income and loss pass through to your personal tax return on Schedule C, with no separate business return to file.
- Flexible banking: You can legally run business payments through your personal bank account. A separate business account still makes bookkeeping and tax preparation easier.
- Full control: You decide pricing, hours, and direction without a partner, shareholder, or operating agreement to consult first.
Disadvantages of a Sole Proprietorship
Personal liability is the main disadvantage. If the business can’t pay a debt or loses a lawsuit, creditors can pursue your personal savings, car, and home, because you and the business are legally the same.
A sole proprietorship can also be hard to raise money for because you can’t sell stock, and banks are often hesitant to lend to sole proprietorships.
Selling the business is more difficult because there’s no entity to transfer. A buyer purchases your individual assets one at a time.
Taxes and Registrations for Sole Proprietors
As a sole proprietor, you still have these federal tax and registration requirements:
- Self-employment tax: Once your net earnings from self-employment reach $400 in a year, you owe self-employment tax on top of your regular income tax. The rate is currently 15.3%: 12.4% for Social Security, which applies up to an annual earnings limit, and 2.9% for Medicare.
- EIN: You need an Employer Identification Number if you hire employees, have a Keogh plan, or file employment or excise tax returns. Otherwise, you can generally use your Social Security number, though many sole proprietors get an EIN to keep that number off client paperwork.
- DBA and local registrations: Any DBA, business license, or seller’s permit you hold may need to be renewed on the schedule your state or locality sets.
When a Sole Proprietorship Stops Being the Right Fit
The transition from a sole proprietorship to an LLC or corporation usually happens when the business takes on more risk, adds partners, or grows to the point where the owner’s personal assets need protection.
Bringing on a business partner, hiring your first employee, or taking on the liability that a client contract or a storefront lease creates are all signals that it’s time to consider an LLC or a corporation. Once you form an LLC or corporation, every state requires you to appoint a registered agent, a person or company that receives legal notices and state correspondence on the business’s behalf.
Harbor Compliance’s business entity comparison walks through how sole proprietorships, LLCs, and corporations differ on liability, taxes, and ongoing filings.
How Harbor Compliance Can Help
Harbor Compliance handles the registrations a sole proprietorship needs now and the filings a new entity will need later:
- DBA filing: Harbor Compliance confirms your business name is available and registers it with the appropriate state or county office.
- EIN registration: Harbor Compliance obtains your federal tax ID from the IRS.
- Registered agent service: When you form an LLC or corporation, Harbor Compliance serves as your registered agent in every state where you operate.
Get your free Harbor Compliance Score to see where your business stands before you take the next step.
DBA (Doing Business As) - A registration that lets a sole proprietor legally operate under a name other than their own legal name.
EIN (Employer Identification Number) - A federal tax ID number issued by the IRS, required once a sole proprietor hires employees or meets other IRS conditions.
Pass-Through Taxation - A tax structure where business profit and loss are reported on the owner’s personal tax return instead of a separate business return.
Registered Agent - The official point of contact appointed by an LLC or corporation to receive legal notices and state correspondence. Sole proprietorships aren’t required to have one.
Self-Employment Tax - The 15.3% tax covering Social Security and Medicare that self-employed individuals pay in place of payroll withholding.
Sole Proprietorship FAQs
No. Registered agent requirements apply to entities that file formation paperwork with the state, such as LLCs and corporations. A sole proprietorship has no formation filing, so it has no registered agent requirement. That changes when you form an entity.
You may need a DBA if you’re operating under a name other than your own, plus any general business license or industry-specific permit your city, county, or state requires. Those requirements exist independently of your business structure, so they apply whether you’re a sole proprietor or a formal entity.
You need one if you hire employees, have a Keogh plan, or file employment or excise tax returns. Otherwise, you can generally use your Social Security number, though many sole proprietors get an EIN so they don’t have to share that number with clients or vendors.
No. A sole proprietor can legally use a personal bank account for business income and expenses. Many sole proprietors open a separate account anyway because it simplifies bookkeeping and tax preparation.
A business co-owned by spouses is generally treated as a partnership for federal tax purposes. If both spouses materially participate and file a joint return, they can elect qualified joint venture status, and each spouse files a separate Schedule C as a sole proprietor.
Business income and loss pass through to your personal tax return on Schedule C. You also owe self-employment tax, currently 15.3%, once your business’s net earnings reach $400 in a year.
Yes. A sole proprietor can hire employees, but doing so requires an EIN and the same employment tax filings any other employer must make.
