Sole Proprietorship: The Complete Guide to the Simplest Business Structure

Over 86% of businesses without employees in the United States operate as sole proprietorships. That's nearly 30 million businesses choosing the simplest path to entrepreneurship. If you're thinking about starting a business or are already running one informally, understanding this structure could save you time, money, and headaches.

A sole proprietorship isn't just a business structure—it's the default state of doing business. The moment you start earning money from a side hustle, freelance gig, or service you provide, you're technically operating as a sole proprietor. But is it the right structure for you? Let's find out.

What Is a Sole Proprietorship?

A sole proprietorship is an unincorporated business owned and operated by one person. Unlike corporations or LLCs, there's no legal separation between you and your business. You are the business, and the business is you.

This means several things in practice:

• Your business income is your personal income
• Your business debts are your personal debts
• You file taxes on your personal return, not a separate business return
• You don't need to register the business with your state (though licenses may be required)

The IRS and your state don't see your sole proprietorship as a separate entity. When someone sues your business, they're suing you personally. When your business makes money, you made that money. This simplicity is both the greatest advantage and the most significant risk of this structure.

How to Start a Sole Proprietorship

Starting a sole proprietorship is remarkably straightforward—so simple that you might already be operating one without realizing it.

Step 1: Start Making Money

Technically, you become a sole proprietor the moment you begin offering goods or services for profit. There's no formal registration required to exist as a sole proprietorship. If you're mowing lawns for cash, selling crafts online, or freelancing on the side, you're already in business.

Step 2: Choose a Business Name (Optional)

You can operate under your own legal name or choose a business name. If you want to use a name other than your own, you'll need to file a "Doing Business As" (DBA) registration with your local government. This lets you open a business bank account and accept payments under your business name.

Step 3: Obtain Required Licenses and Permits

Requirements vary dramatically based on:

• Your location: States, counties, and cities each have their own requirements
• Your industry: Some professions require specific licenses (contractors, cosmetologists, food service, etc.)
• Your activities: Selling products often requires a sales tax permit

Check with your local Small Business Development Center or city clerk's office to understand what's required in your area.

Step 4: Get an EIN (Optional but Recommended)

An Employer Identification Number isn't required for sole proprietors without employees—you can use your Social Security Number for tax purposes. However, getting an EIN is free, takes five minutes online through the IRS website, and offers benefits:

• Protects your SSN from appearing on invoices and tax forms you share with clients
• Required if you ever hire employees
• Needed for some business bank accounts
• Adds a layer of professionalism

Step 5: Separate Your Finances

While not legally required, opening a separate business bank account is one of the smartest moves you can make. It simplifies bookkeeping, makes tax time easier, and helps establish your business's credibility.

Advantages of a Sole Proprietorship

Complete Control

You make every decision. No board meetings, no shareholder votes, no partner disagreements. If you want to pivot your business tomorrow, you just do it. This agility is invaluable for small businesses and freelancers.

Minimal Startup Costs

Compared to incorporating (which typically costs $500-$1,000+ in fees and legal expenses), starting a sole proprietorship can cost nothing beyond any required licenses. You're not paying for articles of incorporation, registered agents, or franchise taxes.

Simple Tax Filing

All business income and expenses flow directly to your personal tax return through Schedule C. You're not filing separate corporate returns or dealing with complex multi-tier taxation. One return covers everything.

For 2025, sole proprietors may also qualify for valuable deductions:

• Qualified Business Income (QBI) Deduction: Up to 20% of net profit if your taxable income is below $191,950 (single) or $383,900 (married filing jointly)
• Section 179 Expensing: Deduct up to $1.25 million of qualifying equipment and software
• Home Office Deduction: If you use part of your home exclusively for business
• Health Insurance Deduction: Self-employed individuals can deduct health insurance premiums

No Ongoing Compliance Requirements

Corporations must hold annual meetings, maintain meeting minutes, file annual reports, and follow strict governance rules. Sole proprietorships have none of these requirements. You simply run your business and file your taxes.

Easy to Dissolve

If your business doesn't work out, there's no formal dissolution process. You stop operating, file your final tax return, and you're done. No state filings, no legal proceedings, no waiting periods.

Disadvantages of a Sole Proprietorship

Unlimited Personal Liability

This is the biggest drawback. If your business is sued or can't pay its debts, your personal assets are at risk—your house, car, savings, everything. There's no legal shield between you and business obligations.

Consider these scenarios:

• A client slips and falls at your home office and sues
• A product you sell injures someone
• You can't repay a business loan
• A vendor sues for unpaid invoices

In each case, your personal assets could be seized to satisfy judgments or debts.

Self-Employment Taxes

As a sole proprietor, you pay both the employer and employee portions of Social Security and Medicare taxes—a combined 15.3% on net self-employment income. This is in addition to your regular income tax.

Employees only see 7.65% taken from their paycheck because their employer pays the other half. As a sole proprietor, you're both the employee and employer.

Limited Access to Capital

Banks and investors are often hesitant to work with sole proprietorships:

• Banks may require personal guarantees or offer less favorable terms
• Investors can't buy equity in your business because you can't sell shares
• Business credit is harder to establish without a formal business structure

Difficult to Transfer or Sell

A sole proprietorship is inseparable from its owner. You can sell the assets of the business, but you can't sell the business itself as a going concern the way you could with a corporation or LLC. When you leave, the business ceases to exist.

Limited Growth Potential

Without the ability to bring in equity partners or issue stock, scaling a sole proprietorship is challenging. Growth typically depends entirely on your personal capacity and whatever debt financing you can secure.

Tax Obligations for Sole Proprietors

Understanding your tax responsibilities is crucial for avoiding penalties and surprises.

Income Taxes

Report all business income and deductible expenses on Schedule C (Form 1040). Your net profit becomes part of your total income and is taxed at your marginal rate.

Self-Employment Tax

If your net self-employment income exceeds $400, you'll owe self-employment tax. Calculate this on Schedule SE. The good news: you can deduct the employer-equivalent portion (7.65%) when calculating your adjusted gross income.

Quarterly Estimated Taxes

Unlike employees who have taxes withheld from each paycheck, sole proprietors must pay estimated taxes quarterly. If you expect to owe $1,000 or more in taxes, you're required to make these payments by:

• April 15
• June 15
• September 15
• January 15 (of the following year)

Failing to make adequate estimated payments can result in penalties.

Record Keeping

Maintain records of all income and expenses. Keep receipts for any deductions you claim. The IRS recommends keeping tax records for at least three years, though some situations require longer retention.

Solid bookkeeping practices from day one will save you stress and potentially money. Track every business transaction, categorize expenses properly, and reconcile your accounts regularly.

When to Consider Other Structures

A sole proprietorship works well for:

• Low-risk businesses
• Testing a business idea before committing more resources
• Part-time ventures and side hustles
• Freelancers with limited liability exposure
• Businesses with minimal capital needs

Consider transitioning to an LLC or corporation when:

Your Liability Risk Increases

If you're selling products, working in clients' homes, giving professional advice, or doing anything that could result in lawsuits, liability protection becomes crucial.

Your Profits Grow Significantly

Once your net self-employment income exceeds $40,000-$50,000, the S-corporation tax election (available through an LLC) can provide meaningful self-employment tax savings. Instead of paying 15.3% on all profits, you'd pay it only on a reasonable salary while taking the rest as distributions.

You Need Outside Investment

If growth requires capital beyond what you can provide or borrow personally, you'll need a structure that allows equity investment.

You Want to Build Business Credit

Establishing credit in your business's name is easier with a formal entity that separates personal and business finances.

You're Concerned About Business Continuity

If you want the business to continue beyond your involvement or be easily transferable, a formal entity structure provides that flexibility.

Common Industries for Sole Proprietors

Sole proprietorships are particularly common in:

• Freelance services: Writing, design, consulting, photography
• Home services: Landscaping, cleaning, handyman work, pet care
• Personal services: Tutoring, coaching, fitness training
• Creative arts: Artists, musicians, crafters
• Professional services: Bookkeepers, real estate agents, insurance agents
• Food services: Catering, personal chefs, baked goods

These industries typically have lower liability exposure and don't require significant capital investment, making the sole proprietorship structure appropriate.

Protecting Yourself as a Sole Proprietor

While you can't create legal separation between yourself and your business, you can take steps to minimize risk:

Get Business Insurance

General liability insurance, professional liability insurance (errors and omissions), and product liability insurance can protect you from many common risks. The cost is often reasonable and provides peace of mind.

Use Contracts

Written agreements with clients and vendors establish clear expectations and can limit your exposure. Include liability waivers where appropriate.

Maintain Separate Accounts

Even though you're not legally required to separate finances, doing so demonstrates professionalism and helps prove that business assets are distinct from personal assets.

Consider an Umbrella Policy

A personal umbrella insurance policy provides additional liability coverage beyond your auto and homeowner's insurance, which can be valuable if you're sued.

Keep Your Financial Records in Order

Whether you stay a sole proprietor or eventually transition to another structure, maintaining accurate financial records is essential. Good bookkeeping helps you understand your business's performance, simplifies tax preparation, maximizes your deductions, and positions you for growth.

Beancount.io offers plain-text accounting that gives you complete control over your financial data—perfect for sole proprietors who want transparency without complexity. Your records stay in simple text files you own forever, making it easy to track income, expenses, and profitability. Get started for free and bring clarity to your business finances from day one.