What is a sole proprietorship? Everything you need to know

One of the very first (and most important!) steps when starting a business is deciding on your business structure. With all the options out there, it can be overwhelming (and sometimes even paralyzing) to make a decision. 

A popular choice for small business owners is a sole proprietorship, because this business structure is fairly simple and easy to start up. Since you’ve clicked on this article (and are, we assume, still reading), that means sole proprietorships have piqued your interest, too. 👀

Luckily for you, in this post, we’ll define what a sole proprietorship is, go over how to start a sole proprietorship, provide the pros and cons of starting a sole proprietorship, and answer some common questions about getting started with sole proprietorships. Let’s get into it! 

What is a sole proprietorship?

A sole proprietorship is a type of business structure that is unincorporated, and has only one business owner who is not legally separate from the business. Many freelance writers, designers, and artists, for example, are sole proprietorships. 

Sole proprietorships are the simplest and cheapest type of business structure. As we mentioned before, this is why sole proprietorships are the most common type of business structure, with most small businesses in the US being sole proprietorships. 

How to start a sole proprietorship

Starting a sole proprietorship doesn’t involve any fancy paperwork or official registration, so once you start doing business, you’re a sole proprietorship! 

This means if you identify as being self-employed, an independent contractor, a consultant, or a freelancer, and you never filed any registration forms for doing business… you’re actually a sole proprietorship. 🤯 

Keep in mind, you still might need to get a license or permit (which is different from registration forms) depending on your business activities and your location. The amount and type of licenses and/or permits you may need greatly depends on your unique situation, but most businesses will need at least one. 

You can use your own legal name as your business name, or you can officially register another business name with your state if you’d like to operate your business under a different name. 

How are sole proprietorships taxed?

Sole proprietorships need to pay federal, state, sales, and sometimes local income taxes on their profits. That sounds like a lot, but it’s actually not that complicated—especially compared to other business structures! Let’s break it down. 

Sole proprietorships pay personal income tax on the profits earned from their business. The forms you’ll definitely need to submit to the IRS as a sole proprietorship are Schedule C (Form 1040), which reports your business income and expenses, and Schedule SE (Form 1040), which reports your self-employment taxes. 

The IRS recommends most sole props pay estimated taxes on a quarterly basis, so you may also need Form 1040-ES. (And, hey, if you end up over-estimating, you’ll get a nice refund.) 

If you made more than $400 in the tax year, you’ll also owe “self-employment taxes,” which include Social Security and Medicare. 

If you have employees, you might need to deduct federal and state unemployment taxes from their wages (not your own!), so you’ll need Form 940. 

We always recommend speaking to a tax pro to know exactly what forms and taxes you’re responsible for. 

Advantages of sole proprietorships

Okay, that was a lot of tax info, so let’s dig into something a little more fun now: a few of the perks of being a sole proprietorship! 

Easy to start

As we mentioned before, unlike other business structures, you don’t need to go through an official registration process or fill out any fancy paperwork, which means it’s quicker to start up a sole proprietorship (and save major time!) and start growing your business ASAP. 

There’s also the flexibility to eventually register as a limited liability company (LLC) or a corporation as you grow your business, so you’re not boxed into being a sole proprietorship forever. 

Low cost

Since you don’t need to officially register your business, you don’t need to pay any registration fees—meaning sole proprietorships are cheaper to set up compared to other business structures. (But remember, you may still need to pay for any business licenses or permits.) 

Tax advantages

A sole proprietorship is a “pass-through” entity, which means the income from your business “pass through” to you and is taxed on the personal level. The benefit of “pass through taxation” is that you aren’t taxed twice on the personal level and the business level (aka double taxation). Getting taxed once is enough for us, thanks.  

An extra spicy bonus: As a sole proprietorship, you might also qualify for a 20% tax deduction!  

Less government involvement 

Unlike other business structures (especially the more complicated ones, like corporations), sole proprietorships aren’t subject to as many strict rules and regulations. 

Of course, make sure you keep accurate financial records and pay your taxes! One of the most efficient and easy ways to track your income and expenses and always be prepared for tax time is through accounting software. Wave’s accounting software makes accounting simple (even if you’re not an accountant!), and helps you keep track of your money so you can make smart business decisions. 

Disadvantages of sole proprietorships

Now, for the disadvantages of sole proprietorships. It’s important to weigh the pros and cons so you can make an informed decision about which business structure is right for you. 

Liability

Not having to register your business unfortunately has a con: you and your business are one in the same, which means legal issues—like getting sued or acquiring debt—fall on you, and your personal assets aren’t safe from getting seized. 

Harder to get funding 

Unfortunately, sole proprietorships are seen as riskier in the eyes of banks and investors, so it can be trickier to get funding compared to other more formal structures. 

If you aren’t able to secure the amount of funding you need to get your business off the ground, make sure you keep a close eye on your finances to ensure you have enough resources to make up for any expenses. 

A one person show 

Being the only owner of your business can be a pretty awesome thing most of the time—you’re the boss! But it can also come with a downside. 

For example, larger businesses usually have specialists for different areas of the business (like finances, marketing, etc.), but as the only business owner, all those responsibilities fall on you… which you miiight not have expertise in. Hiring employees or consultants may also be too pricey for sole proprietors, so it’s up to you to level up those skills. 

Should I start a sole proprietorship or an LLC?

Quick recap: An LLC protects you from any personal responsibility for the debts or liabilities of your business, whereas sole proprietorships are completely responsible for the debts and liabilities of their business. 

Got it? Okay, let’s go over some considerations to take into account when deciding to start either a sole proprietorship or an LLC. 

Here’s when it makes sense to choose a sole proprietorship:

• You want an easy, cheap, and risk-free way to start a business (an LLC may be better suited if you have an intense business plan or plans for major growth) 
• Your business is fairly low risk (the key difference between a sole proprietorship and an LLC is that an LLC personally protects you from liabilities) 
• Your business doesn’t generate large profits (LLCs are better suited for businesses with large profits, or those looking to grow their profits) 
• Your business has a smaller customer base (LLCs are, you guessed it, better for businesses with a large customer base, or those planning to scale) 

Don’t worry if you’re indecisive! As we’ll talk about in the next section, you can always start out as a sole proprietorship and then convert into an LLC. 

How do I convert a sole proprietorship into an LLC?

Some small businesses start as a sole proprietorship, and then eventually transition into an LLC, most typically because LLCs offer more liability protection. We have an entire article on how to form an LLC, so we won’t get too in the weeds in this section, but it is more involved than forming a sole proprietorship. 

You’ll need to: 

• get an employer identification number (EIN) from the Internal Revenue Service (IRS) 
• officially register your business name
• file articles of organization with your state 
• write up an internal operating agreement

Getting started with sole proprietorships

And there you have it—all the info you need to decide if starting a sole proprietorship is right for you. A sole proprietorship is a great choice for freelancers or small business owners with no or few employees, or for business owners ready to quickly start a business before eventually growing into an LLC or another business structure. 

Sole proprietorships are cheap, easy, and simple to get started with, but remember to weigh the pros and cons and consider your own unique situation. 

As we mentioned before, tools for small business money management can make your life way easier as a sole proprietor (or any business structure, really). The key for reducing headaches and improving your efficiency is having all the money tools you need in one place, so you don’t have to do a ton of research or cobble together a bunch of different software. 

This is why we recommend Wave’s suite of money management tools. Wave keeps both your financial and customer information in one place, with an at-a-glance, user-friendly dashboard. You can manage your cash flow, get paid fast online, know who owes you and who you owe, access a trusted bookkeeping expert, pay your employees and pay yourself, all in one place, so you’re always in the driver’s seat. Create your account today to get started!