A sole proprietorship is the most simple form of business. If you begin to conduct business activities without taking any steps to formally register or incorporate your business, you are a Sole Proprietor. Sometimes sole proprietorships are called sole traders or proprietorships. A sole proprietorship has one owner who pays personal income taxes on the profits from their business. Sole Proprietorships lack any distinction between the business and the owner as an individual, thus have unlimited liability risk.Table of Contents
- Sole Proprietor Advantages
- Sole Proprietors Disadvantages
- Sole Proprietor Frequently Asked Questions
Sole Proprietor Advantages
There are some advantages for the business structure sole proprietorship when compared to other business structures.
- Simple and Inexpensive to Start
- Straight forward tax filings
Simple and Inexpensive to Start
One of the most advantageous aspects of operating as a Sole Proprietor is how simple and easy it is to get started. Sole Proprietorships don’t require any formal registration per se thus there are no state filing fees like those associated with forming an LLC or Corporation. If you start doing business activities like buying supplies or performing a service for pay, you are a Sole Proprietor. If you are a Sole Proprietor you need to operate under your name by default. If you want to operate under a different name, be aware that you’ll to file for a DBA/Trade name. Also keep in mind that depending on the type of business activities you’ll be doing you will also need to file for Federal, State and Local business licenses and permits.
Straight Forward Tax Filings
Since there is no separation between your business and you as a person, filing taxes for a Sole Proprietorship is very straightforward. Simple file your normal Form 1040 and include a schedule C to document your business income.
Sole Proprietors Disadvantages
While starting off as a Sole Proprietor is simple, easy and low cost there are a number of disadvantages that should be considered:
- Unlimited Liability Risk
- More Difficult to Raise Capital
- Maximum Exposure to Self-Employment Taxes
Unlimited Liability Risk
The most significant disadvantage operating as a Sole Proprietor, arguably, is the lack of any liability protection. Since a business operated as a Sole Proprietorship is not recognized as a separate entity from its owner, Sole Proprietors are open to unlimited liability risk. A lack of personal limited liability protection means that if you were sued or had business debts and obligations that you were unable to meet, the entirety of your personal assets could be used to pay/cover these obligations. This means that your personal bank account, home, car and more are at risk. For this reason, many sole proprietors choose to convert their sole proprietorship to an LLC once their business has gained some success and the liability risks of a sole proprietorship outweigh the advantages.
If your business activities have any type of sizeable risk, a Sole Proprietorship is likely not a good business structure for your business. You may want to consider a different business structure such as an LLC or Corporation that provide limited liability protection.
More Difficult to Raise Capital
As a sole proprietor it is much harder to raise capital through investors and harder to obtain business loans and lines of credit. If you operate as a sole proprietor you can be the only owner, thus its not possible to sell ownership stakes in your company to others, making it basically impossible to attract investors. Outside of investors its also very difficult to get financing and credit. Lenders view a sole proprietorship as a much riskier investment, thus are much less likely to lend to businesses that are sole proprietorships.
Maximum Exposure to Self-Employment Taxes
For those who are unfamiliar, self-employment tax refers to the SECA tax for Self-Employment Contribution Act tax. This is the equivalent of the FICA (Federal Insurance Contributions Act) tax that are applicable to all employees where the tax burden is split 50/50 between the employer and employee. Unfortunately for a self-employed individual, they must shoulder the entire burden of this tax. This tax must be paid by all self-employed individuals, however unlike businesses formed as an LLC that can elect S Corporation taxation status to reduce their self-employment burden, a Sole Proprietor does not, thus they are subject to the maximum levels of taxation in regards to self-employment (SE) tax. This can result it a much higher amount of self-employment tax liability for Sole Proprietors that have very successful businesses.
If you have a business that is expected to be very profitable it could be helpful to consider a different business structure like an LLC that can allow for S Corporation taxation status. If you want to learn more about the specific tax implications of this we advise that you seek the guidance of a tax professional or lawyer for guidance.
Looking for a more in-depth review of the pros and cons of operating as a Sole Proprietorship? Check out our guide:
Sole Proprietorship Advantages and Disadvantages
Starting a Sole Proprietorship
If you’re looking to start a sole proprietorship in your state, choose your state from the list below to get state specific directions on starting your sole proprietorship:
- New Hampshire
- New Jersey
- New Mexico
- New York
- North Carolina
- North Dakota
- Rhode Island
- South Carolina
- South Dakota
- West Virginia
Sole Proprietor Frequently Asked Questions (FAQs)
What types of businesses commonly operate with the business structure sole proprietor?
A few examples of a business that operates as a sole proprietor include: A person who sells created goods a craft fairs or farmers markets. Someone who acts as a consultant or speaker often operate as sole proprietors. Freelancers, home health care specialists, cleaning services and landscapers are commonly operated as sole proprietorships. Sole proprietorships are also generally used for “hobby” businesses where a person has a normal job and does an occasional additional job that they make a profit from.
What is the difference between sole proprietorships and self-employment?
Sole Proprietorship refers to single owner businesses that are unincorporated or formed as an LLC. Self-employment is a more general reference to any and all individuals who work for themselves and can include Sole Proprietors as well as those who operate businesses as Partnerships and LLCs.
What is the difference between a DBA and a sole proprietorship?
A DBA (“Doing Business As”), also referred to a Trade Name, Fictitious Name or Assumed Name is a state or local registration that allows an organization to operate under a name different than their legal name. A sole proprietorship refers to a legal structure where there is one owner and the business is not established as a formal entity such as an LLC or Corporation. In most cases a Sole Proprietor will need to file a DBA (or equivalent) if they plan on operating using any name different from their individual name.
How are sole proprietorships taxed?
Sole proprietors are pass-through taxation entity meaning that any business income (or losses) as passed-through to the owners personal taxes and paid by the owner. Sole proprietors are also subject to self-employment tax.