A sole proprietorship is the simplest business entity, with one person (or a married couple) as the sole owner and operator of the business. If you launch a new business and are the only owner, you are automatically a sole proprietorship under the law. There’s no need to register a sole proprietorship with the state, though you might need local business licenses or permits depending on your industry.

Freelancers, consultants, and other service professionals commonly work as sole proprietors, but it’s also a viable option for more established businesses, such as retail stores, with one person at the helm.

Pros of Sole Proprietorship

  • Easy to start (no need to register your business with the state).
  • No corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc.
  • You can deduct most business losses on your personal tax return.
  • Tax filing is easy—simply fill out and attach Schedule C-Profit or Loss from Business to your personal income tax return.

Cons of Sole Proprietorship

  • As the only owner, you’re personally responsible for all of the business’s debts and liabilities—someone who wins a lawsuit against your business can take your personal assets (your car, personal bank accounts, even your home in some situations).
  • There’s no real separation between you and the business, so it’s more difficult to get a business loan and raise money (lenders and investors prefer LLCs or corporations).
  • It’s harder to build business credit without a registered business entity.
  • Taxes sole proprietors pay
    • Taxes are not automatically withheld from a sole proprietor’s income like they would be from an employee’s wages. Because taxes are not withheld, sole proprietors must pay self-employment tax and estimated taxes.
    • Self-employment tax includes both the employer and employee portions of Social Security and Medicare taxes. Together, these two tax obligations are known as the Self-Employment Contributions Act (SECA) tax. Often, you will need to pay self-employment taxes quarterly with an estimated tax payment.
    • Estimated taxes are like income taxes taken out of an employee’s paycheck. Sole proprietors must estimate the amount of income tax owed to the government and pay them quarterly.

Registering a Sole Proprietorship

Sole proprietors who do not want to use their legal personal name in their business name can use a fictitious name (trade name) if they file a DBA (Doing Business As). The DBA must be filed with the state or the county clerk—depending on the business’s location.

For example, if Josephine Giardo wants to market her business by the name “Josephine’s Yoga Retreat” rather than “Josephine Giardo Yoga Studio,” she would need to file a DBA for the name that doesn’t include her full first and last name.

Many states also require that businesses have their fictitious name published in one or more approved newspapers or other publications in the county where it was filed.

Fictitious names may need to be renewed, so it’s important to verify the county and state requirements.

Licenses and Payroll

Getting started as a sole proprietor can be as easy as setting up a website. Depending on local rules, you may not need any licensing at all. Some localities do require a business license and others have zoning rules that allow some types of business and not others to be home-based. Licensing also depends on the type of business you are doing.

If you have employees, the situation immediately gets more complicated, because registering for payroll taxes and managing employee benefits (as well as overall accounting) become issues. This usually limits the size of “Mom & Pop” operations to a few (if any) employees and a small footprint.

Sole Proprietorship Taxes

The required records are tax-based. Net profit (or loss) is straightforward. The business income is part of your overall household income. The main difference is that as a sole proprietor, you are required to pay the entire amount of social security and Medicaid contribution. Most single owner businesses file quarterly estimated taxes.

In many tax brackets, running a sole proprietorship is an advantage. Business related expenses are deductable and can offset other income. Two important deductions are for a home office and automobile mileage. You are even allowed to claim a loss for your business and offset the taxes you would otherwise pay on a second income. The IRS does, however, expect you to make money sooner or later. It is unwise to tempt an audit by losing money consistently.

Sole Proprietorship Liability

As the owner, you will keep all the assets and liabilities under your own name. While the business can have another name, this type of structure doesn’t separate you legally from business obligations. If you are sued though, it will be a direct attack against your personal assets. Your non-business belongings (house, property, and savings) are all at risk.

This is one of the major downsides to a sole proprietorship. We live in a society that is quick to place blame and attempt recovery through the courts. One way to deal with this and maintain sole ownership is to buy liability insurance. Many home insurance policies offer a tie-in for liability under an umbrella policy – check with your insurance agent. Bonding is also available in many industries.

There are ways to shield your assets through a trust and in retirement portfolios. Unfortunately, many sole proprietors “go naked” and hope for the best.

Credit and Financing for Sole Proprietorships

Loans are an important issue for most businesses. They allow for expansion and smooth out cash flow bumps. As a sole proprietor, any loans you receive will be based on your personal credit history and assets. Banks will also look at your risk profile.

In effect, any loan you receive will be a personal loan. For this reason, it is common for sole proprietors to leverage their home (with a second mortgage) or any business property. The current credit environment has made these types of loans difficult to obtain in many areas of the country.

Because a single owner business is an extension of you, if you go bankrupt, it is a personal bankruptcy. All of your assets are at risk. More than anything else, this is a good reason to carefully consider the protections offered by incorporating or forming an LLC.

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