A sole proprietorship is a small, unincorporated business run by a single person. This business structure is easy to set up and doesn’t require much paperwork. The entity does not exist apart from the owner, so if you start one, then you can use your first and last names as your business name or adopt a doing-business-as (DBA) name.
Once you’ve got your business up and running, any profits you generate will go to you directly. However, you’ll also be personally responsible for the debts and financial obligations that come with the company.
Key Takeaways
- Sole proprietorships are the default classification for any single-owner business activity.
- Sole proprietorships do not need to file any formal paperwork with the IRS.
- Assets of the business remain legally owned by the sole proprietor.
- The sole proprietor is legally obligated to pay all the debts and liabilities of the business.
Sole Proprietorship Examples
The best businesses to be organized as sole proprietorships are those where there is one owner who is working by themselves in a service-based business. Here are some common examples of sole proprietorships:
- Gig workers
- Freelancers
- Independent contractors
- Repair services
Businesses That Make Good Sole Proprietorships
Sole proprietorships can come in different shapes and sizes. The best businesses to set up as sole proprietorships are those that require very little capital investment and where the owner generates all the income.
If you are one or more of the following types of professionals, then a sole proprietorship might be good:
- Electrical contractor
- Freelance writer
- Plumber
- Direct online seller
- Gig worker
- Tutor
- Housekeeper
- Nanny
- Mechanic
- Barber
- Tailor
- Construction worker
Businesses That Shouldn’t Be Sole Proprietorships
Typically, these types of businesses require heavy capital investment, and you may want to raise capital through debt or equity. Another reason to avoid being a sole proprietorship is if you have employees. This includes the following business categories:
- Restaurants
- Hotels
- Real estate developers
- Car dealerships
- Construction firms
- Law firms
- Accounting firms
- Engineering firms
If you want to form one or more of the above, you should think about how you want to organize your business before you get started. You might be able to save considerable taxes by forming an S Corporation (S-corp) instead. You can read our guide on what an S-corp is, which covers how it works, how to save money on taxes as an S-corp, and more.
How To Form a Sole Proprietorship
Starting a sole proprietorship is quite simple. You can get started by following these quick steps below:
Step 1: Pick a business name.
You can use your own name. Alternatively, you can make up a business name—this is called a DBA name. However, before doing this step, you should check with the business registration office in your state to ensure that the business name is available and doesn’t conflict with any existing business name.
Step 2: Obtain an employer identification number (EIN).
To avoid using your Social Security number for business purposes, you should obtain an EIN. One of the easiest ways to apply for an EIN is to apply online through the IRS website. You also have the option to apply for an EIN by mail or fax using Form SS-4—and our guide on how to get an EIN will walk you through both options.
Step 3: Register your business if necessary.
Most state governments will require you to register your business with them. This could be your state’s department of assessment and taxation, department of revenue, or secretary of state. You may also need to get a business license, a tax registration, and other permits or certificates. Check with your state to find out what is needed.
Step 4: Track income and expenses.
As a sole proprietor, you are responsible for keeping updated and accurate records of your business activity. Accounting and keeping books can be quite challenging, but to assist you with this process, read our bookkeeping and accounting tips to learn more about how to keep your business records in order. You might also find it helpful to use an automated cloud-based system to keep all of your business’s records in one place like QuickBooks Online or Wave.
Step 5: File your first Schedule C.
To file your first Schedule C, you will need to:
- Step 1: Gather your business records. You will need to keep accurate records of how much money your business made and how much it cost you during the year. This includes payments, bills, bank statements, and any other financial records.
- Step 2: Complete Schedule C. You can do this by hand or by using tax software. The form asks for details about your business, such as its name, type of business, and accounting method. You will also need to report your income and expenses on the form.
If you need help filling out the form, you can see our guide on how to fill out your Schedule C.
How Sole Proprietorships Are Taxed
Your business profits will be reported on Schedule C because, as a sole proprietor, you are considered to be self-employed. This means you must pay self-employment taxes, which include Social Security and Medicare taxes. The self-employment tax rate is currently 15.3% of your net earnings from self-employment.
Self-employment tax is a major disadvantage of being classified as a sole proprietorship. You read our article on the pros and cons of a sole proprietorship to learn more.
You’ll pay income tax on your Schedule C income at your personal income tax rate. In addition to self-employment and income taxes, sole proprietorships might be subject to state and local taxes, sales and use taxes, and excise taxes. We have an ultimate guide on sole proprietorship taxes to help you further.
Frequently Asked Questions (FAQs)
No, so long as you do not have employees, you will not need an EIN. However, if Sole proprietors don’t have an EIN they’ll need to disclose their social security number on tax forms like 1099s sent to contractors.
No, you cannot technically sell a sole proprietorship, but you can sell all of the business assets. Business assets can include the name of your company and any customer goodwill.
When the owner of a sole proprietorship dies, the business will be dissolved, and any remaining assets are included in the owner’s estate. The dissolution of the business has no tax effect since the assets were already considered owned by the individual.
Bottom Line
Sole proprietorships may be the simplest type of business to form, but you still want to ensure that you are setting it up the correct way. You will need to choose a business name, obtain an EIN, register for licenses and permits, track income and expenses, and file any necessary tax forms. Be sure to follow our helpful tips when starting your sole proprietorship.
