What Is a Sole Proprietorship?

A sole proprietorship is an unincorporated business that has just one owner who pays personal income tax on profits earned from the business. Many sole proprietors do business under their names because creating a separate business or trade name isn’t necessary.

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Also referred to as a sole trader or a proprietorship, a sole proprietorship is the easiest type of business to establish or take apart, due to a lack of government regulation. As such, they are very popular among sole owners of businesses, individual self-contractors, and consultants. Most small businesses start as sole proprietorships and either stay that way or expand and transition to a limited liability entity or corporation.

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Understanding a Sole Proprietorship

If you want to start a one-owner business, the simplest and fastest way is through a sole proprietorship. A sole proprietorship begins when you begin conducting business. It doesn’t require filing federal or state forms and has few regulatory burdens, making it an ideal way for self-employed people to start.

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A sole proprietorship is very different from a corporation, a limited liability company (LLC), or a limited liability partnership (LLP), in that no separate legal entity is created. As a result, the business owner of a sole proprietorship is not exempt from liabilities incurred by the entity.

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For example, the debts of the sole proprietorship are also the debts of the owner. However, the profits of the sole proprietorship are also the profits of the owner, as all profits flow directly to the business owner.

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Advantages and Disadvantages of a Sole Proprietorship

Advantages

The main benefits of a sole proprietorship are the pass-through tax advantage, the ease of creation, and the low fees for creation and maintenance.

• The tax benefits. Income generated from a pass-through business is only subject to a single layer of income tax and, in some cases, may be eligible for a 20% tax deduction. Along with slashing the corporate tax rate, the Tax Cuts and Jobs Act (TCJA) of 2017 added a tax break for pass-through entities that essentially allows them to deduct up to 20% of qualified business income. That deduction can result in huge savings and runs until Jan. 1, 2026—unless extended by Congress.2

• With a sole proprietorship, you do not need to fill out a tremendous amount of paperwork, such as registering with your state. You may need to obtain a license or permit, depending on your state and type of business. But less paperwork allows you to get your business off the ground faster.

• The tax process is simpler because you do not need to obtain an employer identification number (EIN) from the Internal Revenue Service (IRS). You can obtain an EIN if you choose to, but you can also use your own Social Security number (SSN) to pay taxes rather than needing an EIN.3

• With a sole proprietorship, you also don’t need a business checking account, as other business structures are required to have. You can simply conduct all your finances through your account.

 

Disadvantages

• The following are some of the most common disadvantages of sole proprietorships.

• When a business is registered, it has some legal protections. For example, a sole proprietorship provides no liability protection to the owner. By contrast, an LLC has protection against creditors seizing the owner’s assets, such as their home.

• The unlimited liability that goes beyond the business to the owner and the difficulty in getting capital funding, specifically through established channels, such as issuing equity, bank loans, or lines of credit. Banks prefer to work with companies that have a track record and generally view those who are starting with a small balance sheet as high-risk borrowers. Obtaining equity from large investors can also be difficult.