What is a Sole Proprietorship?

What is a sole proprietor? A sole proprietor is not a legal entity. The IRS defines a sole proprietor as someone who owns an unincorporated business. A sole proprietorship is a simple, default entity formation. It is not legally separate from its owner.

What does sole proprietor mean? How do you know what business to form as a sole proprietor? Let’s look at the advantages and disadvantages of this formation. Likewise, we will share when a sole proprietor may form an LLC.

Key Characteristics of a Sole Proprietorship

A sole proprietorship is the simplest and most common business structure, owned and operated by a single individual. It offers complete control over business decisions, making it easy to start and manage. Unlike corporations or LLCs, it does not require formal registration, although permits or licenses may still be needed.

One key feature is that the owner and the business are legally the same entity, meaning the owner is personally liable for debts and obligations. Profits are taxed as personal income, simplifying tax filing but limiting liability protection. This structure works well for small businesses and freelancers due to its low startup costs and minimal paperwork.

How to Start a Sole Proprietorship

Sole proprietors are low-risk. This means a business may start out unincorporated if it is low risk in nature. The same is true for businesses that require little investment to start up. You may name the business after yourself. Likewise, you may file for a doing business as name (DBA). This is a trade name under which you will do business.

This formation is affordable and requires little filing paperwork. The owner receives all the business profit. They will report all profits and losses on the individual’s tax return.

This individual may be their own boss. They have flexibility in the role to set their own hours. A sole proprietor spends time doing work they are passionate about. They may exercise full control as the business owner.

However, a sole proprietor also assumes full responsibility. This is responsibility for anything — good or bad — that may impact the business.

For example, let’s say there is business risk. A sole proprietor is an unincorporated business. As a result, it is not treated as a separate legal entity. As such, the owner, is personally responsible for any liabilities.

Types of Sole Proprietorships

Sole proprietors often begin as very small businesses. An entrepreneur may pursue a hobby they enjoy. For example, writing or photography. Consequently, these businesses often start with a small customer base.

Gradually, this hobby may grow its customer base, expand its offerings, and start to earn a profit. As soon as you start reporting your income to the IRS, this hobby officially engages in business activity. It then graduates into a sole proprietorship.

What are some types of hobbies that may eventually turn a profit? Here are a few examples:

• Writing. This includes ghostwriting, blogging, and freelancing for online outlets.
• Video blogging or streaming.
• Photography.
• Artist.
• Tutor.
• Lawn care provider.
• Yoga instructor.
• Freelance professionals, which may include consultants, designers, writers, developers, and speakers.

Remember that a sole proprietor is usually a business with limited growth potential. It also has low overhead expenses. As the business grows its customer base and increases its profit, it will need to consider incorporating as a legal business structure.

Sole Proprietor Advantages

We understand what is a sole proprietor. Now, let’s review the advantages.

• Ideal for individuals that wish to exercise full control over their business.
• A good fit for low-risk small businesses.
• Inexpensive.
• Easy to form and set up with little paperwork.

Sole Proprietor Disadvantages

Here are some of the disadvantages of starting a sole proprietorship.

• No limited liability protection. A sole proprietor is unincorporated. It is not legally separate from its owner. The owner’s personal assets may be at risk in the event of an unforeseen circumstance such as a lawsuit. These assets may include cars and houses.
• Taxes. Taxes are significantly more expensive. Incorporating a business provides tax benefits including the ability to elect an S Corp filing. This allows owners to avoid double taxation. However, a sole proprietor is considered self-employed. As such, they must pay both income tax and self-employment tax, which covers Social Security and Medicare obligations, each year. This may add up to an expensive tax bill.
• Funding difficulty. It will be difficult to raise capital, receive a loan, or interest inventors in an unincorporated business. Without a formal business structure, your sole proprietorship may be seen as unprofessional through the eyes of investors.

Sole Proprietorship vs. Other Business Structures

A sole proprietorship stands out for its informality compared to other business structures. It’s the easiest type of business to start, requiring minimal paperwork and no formal registration with the state, unless operating under a DBA. This simplicity makes it appealing for freelancers, consultants, and small business owners who want to get started quickly.

In contrast, LLCs (Limited Liability Companies) and corporations involve more formalities, such as filing articles of organization or incorporation, drafting operating agreements, and maintaining annual reports. These structures also provide limited liability protection, shielding personal assets from business debts—a benefit sole proprietors don’t have.

While partnerships offer shared ownership, and LLCs combine flexibility with liability protection, a sole proprietorship’s low costs and direct control make it ideal for single owners who want to test a business idea without the complexity of formal structures. However, it’s important to weigh the lack of personal liability protection when choosing this structure.

Legal Considerations

A sole proprietorship is the simplest business structure, but it comes with unlimited personal liability. Since the business and owner are legally the same, the owner is personally responsible for all debts, lawsuits, and obligations.

This means personal assets, such as a home or savings, can be used to settle business debts. Sole proprietors must also ensure they have the proper licenses and permits required by their state or local government to operate legally. While there are fewer formalities compared to other structures, sole proprietors still need to maintain proper records and contracts to protect their business interests.

Tax Considerations

For tax purposes, a sole proprietorship is treated as a pass-through entity, meaning the business’s income is reported directly on the owner’s personal tax return using Schedule C. Profits are taxed at the owner’s individual income tax rate, which simplifies the filing process but does not provide the tax flexibility offered by other structures. Sole proprietors are also responsible for paying self-employment taxes, covering Social Security and Medicare contributions, and may need to make quarterly estimated payments to avoid penalties. While tax filing is straightforward, business owners can benefit from deductions for expenses like equipment, home offices, and mileage. Those with employees or a separate business bank account may also need an EIN (Employer Identification Number) to keep business finances organized and compliant.

A Sole Proprietorship Example

Jake’s Web Design is a small business owned and operated by Jake, a freelance web developer who builds custom websites for clients. Since Jake works independently and hasn’t formed a separate legal entity, his business operates as a sole proprietorship.

Jake uses his personal Social Security Number (SSN) for tax purposes and reports his business income and expenses on Schedule C of his personal tax return. To operate under the name “Jake’s Web Design” instead of his legal name, he files a DBA (Doing Business As) with his local county clerk’s office.

As the sole owner, Jake enjoys full control over his business decisions, including pricing, client management, and project timelines. However, he is also personally liable for any debts, disputes, or legal claims related to his work. To keep his finances organized, Jake opens a business bank account and tracks expenses such as web hosting, software subscriptions, and marketing costs.

Jake’s business is a great example of how a sole proprietorship allows freelancers and independent contractors to start and grow their business quickly while maintaining flexibility and low overhead costs.

Should You Form an LLC?

It is possible to run an unincorporated business. As such, you may continue to act as a sole proprietor.

However, it may be wise to incorporate a business. This is helpful for business growth. Forming an LLC provides your business with limited liability protection. In conclusion, this ensures the business receives structure throughout its lifecycle.

Let MyCorporation assist you in forming an LLC. Visit us at mycorporation.com or call us at 877-692-6772 to incorporate today.