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A sole proprietorship is one of the easiest types of business to form since there is no formal distinction between you and the business. You simply begin engaging in business activities.
Advantages of a sole proprietorship include its simplicity and that you receive all the profits from the business. However, you’re also responsible for all liabilities and debts.
If you’re interested in starting a business, here’s what you need to know about sole proprietorships.
What is a sole proprietorship?
Simply, a sole proprietor is someone who owns an unincorporated business by themselves.
Many people ask, “Is a sole proprietorship an LLC?” and the IRS says they’re not the same. A single owner of an LLC can decide whether to have their business designated as a sole proprietorship or corporation for tax purposes.
A sole proprietorship is the most common type of business, which isn’t a surprise since it’s simple to organize and run. Some examples of sole proprietorships include:
- Offering freelancing services to a variety of clients
- Selling items online through Etsy, Amazon or eBay
- Making money through affiliate marketing on a website
- Participating in the sharing economy, driving for Uber or Lyft or hosting lodging via Airbnb
- Teaching various skills (music, dancing, etc.) to others
- Babysitting or pet sitting
Just about any activity you do to make money could be considered a sole proprietorship, providing you with a business structure.
How to form and register a sole proprietorship
Forming a sole proprietorship can happen automatically — even if you aren’t aware of it. There is no formal action to take. Doing business activities qualifies you as a sole proprietor. You do, however, need to be the only owner of the business.
Even though you don’t need formal paperwork to form a sole proprietorship, you do need to make sure you’re following the business and licensing laws of your state or local government. Many cities and states have requirements for business licenses, so you might have to register with your state, county or city.
Also, when you engage in certain activities, you might need a permit. For example, if your sole proprietorship engages in construction or if you want to sell goods out of a retail storefront, you might need to abide by local permitting laws. Check with your city and state governments to see what types of activities require business permits.
If you’re operating under a different name than your own, you’ll need to set up a “Doing Business As” (DBA) name. Look through your state’s business database to see if someone else has chosen that business name.
Many states require you to register a DBA name, even though it doesn’t grant any specific legal protection for your business. Double-check with your state to determine how to proceed. You might not have to register a DBA, but it might be a good idea so that you can obtain an Employer Identification Number (EIN) from the IRS and open a business bank account to keep your business finances separate from your personal finances.
Sole proprietorship vs. other legal business entities
Besides sole proprietorships, there are other legal business entities, such as LLCs (limited liability companies) and S corporations or S-corps. Understanding the differences can help you decide what type of business structure is right for you.
Sole proprietorship vs. LLC
With a sole proprietorship, there is no difference between you and your business. However, an LLC can be owned by more than one person and offers some degree of protection if you end up with business liabilities.
An LLC, though, requires more paperwork to register and usually comes with a filing fee. You might also have to pay annual registration fees and renewals, depending on the state’s LLC regulations.
Finally, you can choose how you want to be taxed. LLCs can be taxed as a sole proprietorship, partnership or corporation. As a sole proprietorship, you’re taxed as a self-employed person.
Sole proprietorship vs. S-corp
An S-corp is fairly common, although not as much as sole proprietorships and LLCs. This is a pass-through entity, like a sole proprietorship or LLC, so the business itself doesn’t get taxed, although those who receive distributions from the company see that income taxed.
S-corp owners, also called shareholders, do receive some liability protection. The owners are not personally responsible for the company’s debt if it can’t be repaid. With an S-corp, unlike a sole proprietorship, your business is a separate entity from you.
Check with your state to see how to register an S-corp and understand the annual reporting requirements.
Pros and cons of sole proprietorships
Just like any other type of business entity, there are pros and cons to sole proprietorships. There isn't a single type of entity that's the overall best option. Instead, you'll need to ensure that you form your business under the entity that makes the most sense for you and your business. Carefully measure the pros and cons of this decision before moving forward.
- Easy to form: No actual requirements to register as a business
- Cheap: Costs are very low — and sometimes nonexistent
- No need for a business bank account: Even though you can get one — and should keep business finances separate — you don’t need a business bank account
- Tax prep is simple: Low tax rates (depending on your marginal bracket) and simple tax filing since you don’t need a separate form
- Personal liability: While other structures limit your personal liability for employee actions and obligations, you are completely on the hook with a sole proprietorship
- It can be hard to raise funds: Without a business structure that allows for partners or shareholders, you might have a hard time raising the money you need to grow
- You might not be able to get a business loan: For some sole proprietorships, it can be difficult to qualify for a business loan; instead, you might be required to use a personal loan
Sole proprietorship FAQs
Here are the answers to common questions about sole proprietorships.
What is a sole proprietorship?
A sole proprietorship is a business structure in which you and your business are treated as the same entity.
Is a sole proprietorship an LLC?
No, a sole proprietorship is not an LLC. However, a single-member LLC can elect to be treated as a sole proprietorship for tax purposes.
How can I set up a sole proprietorship?
Begin business activities. If you’ve already been making money, you might already be a sole proprietorship. There is no formal process, although there might be state and local regulations for permits and licenses.
What’s the difference between a sole proprietorship and an individual?
There is no difference between the two. For all intents and purposes, you are the same. You get all the profits and are personally responsible for the losses and liabilities of the business.