What Is a Sole Proprietor?

Sole proprietors own their own unincorporated business. Businesses are unincorporated when they have not been registered with the state. This business type differs from legal entities like limited liability companies (LLCs) and corporations.

Sole proprietorships appeal to self-employed freelancers and independent contractors because they are low-cost and easy to set up. Still, small business owners should be aware of some risks before they start.

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Key Takeaways

• A sole proprietor is someone who owns an unincorporated business.

• Sole proprietorships form when the owner names their business and obtains the necessary licenses and permits required in their state.

• Sole proprietorships may need to file a DBA (doing business as) registration with the state.

• Sole proprietors can invest in individual retirement accounts and pensions that may reduce their tax burden.

• Sole proprietorships can be risky because they do not shield the owner from personal liability for their business debts.

Understanding Sole Proprietors

If someone owns a startup but has not filed any paperwork with the state where they do business, there is a good chance they are a sole proprietor. This type of business entity differs from LLCs and corporations, which require the business owner to register their business with the state.

The sole proprietor owns the business and anything owned by the business. However, the sole proprietor is also responsible for any debts or obligations brought on by their business activity.

Establishing Sole Proprietorships

Starting a sole proprietorship is as easy as obtaining the necessary business licenses, securing permits, and deciding on a name for the business.

Different businesses require different types of permits and licenses. A sole proprietor is responsible for obtaining all necessary licenses and permits for the business from their federal, state and local governments.

Most states require the owner of a sole proprietorship to register a trade name. This is called “doing business as” (DBA). New business owners should confirm that their DBA isn’t already taken by another business. This will not be a problem if using their own name. However, if using a made-up name, they will need to register both that name and their legal name. The DBA registration requirements vary by state.

Owners can check the availability of their chosen DBA by referring to records stored with their county clerk, secretary of state, and the U.S. Patent and Trademark Office’s trademark search tool.

Startup owners with both a DBA and federal tax I.D. number, also known as an Employer Identification Number (EIN), can open a business bank account.

Advantages of a Sole Proprietorship

Tax Advantages

Sole proprietors face an income tax on all net profits of their business, but can take tax deductions. Taxes are simple to file as all profits and losses are reported on the business owner’s personal tax return. An owner’s tax rate depends on their income. This means the sole proprietorship itself is not subject to taxation in the same manner as a corporation, avoiding double taxation.

Additionally, sole proprietors are allowed to deduct up to 20% of most types of business income on their personal federal income tax returns. Finally, owners can elect to contribute a portion of their business income to an individual retirement account (IRA) or pension fund. This allows owners to withdraw this money later when they may be in a lower tax bracket.

Sole Decision-Making

Sole proprietors enjoy full control of the business and are responsible for all business decisions. They are not required to report to a board of directors, which they would as a corporation.

Fewer Formalities

Sole proprietors do not have to create corporate bylaws or LLC agreements. There is much less record-keeping than formal business entities. Sole proprietorships do not have to file annual reports with the state or pay franchise tax fees. Entrepreneurs may favor sole proprietorships because there are fewer requirements.

Additionally, a sole proprietor can use their own social security number for filing state and federal tax returns. However, if they have employees, they must apply for a Taxpayer ID Number with the Internal Revenue Service (IRS).

Disadvantages of a Sole Proprietorship

Legal Liability

Debts brought on by business activity can put the sole proprietor’s personal assets at risk. For example, suppose a sole proprietor’s business falls into debt. In that case, creditors can force them to sell their personal property to satisfy the business’s obligations. This differs from other business types like LLCs and corporations, which are considered separate legal entities from their owners and offer more risk protection for individual owners. These separate legal entities only have the business assets at risk.

Self Employment Taxes

Self-employed individuals have to pay self-employment taxes such as Social Security and Medicare. These taxes are 15.3% on the sole proprietorship’s earnings.

Answering Your Legal Questions

Setting up your sole proprietorship is quick and easy. But what then? New business owners often have questions about DBAs, tax filing, and risk aversion. In these instances, it’s best to contact a business lawyer who can help set up the right business structure for you.

Related Resources

• Pros and Cons of Different Business Names
• How to Write a Business Plan
• Getting a Loan for a Small Business