Key Takeaways

  • A sole proprietorship is the simplest business structure, created automatically when one person begins doing business.
  • The legal requirements to start a sole proprietorship include complying with local registration rules, obtaining licenses and permits, and following tax laws.
  • Sole proprietors may need to register a business name (DBA), file for an EIN, and secure zoning or professional licenses depending on their activities.
  • Owners are personally liable for debts and lawsuits, making liability insurance an important safeguard.
  • While low-cost and flexible, sole proprietorships offer no separation between business and personal assets.

Governing law of sole proprietorship: If you own a sole proprietorship, you do not have to register it as a limited liability company (LLC), fill out special forms, or pay any fees to start your business. However, you must comply with local and state laws regarding business registration, licensing, and permit laws based on where you live.

What Is a Sole Proprietorship

A sole proprietorship is a type of business run by only one person. As such, it is not registered as a corporation or limited-liability company (LLC).

Since a sole proprietorship is relatively simple to create, you might be a sole proprietor and not know it. For example, if you are a freelance graphic designer, a woodworker, an accountant, or you do any one-person job that earns you a commission, you are a sole proprietor because you are self-employed.

Navigating the Laws Governing Sole Proprietorships

You might have to register your sole proprietorship in your city or county. If required to register your business, declare that you are running a sole proprietorship. In any case, you will be required to pay a minimum tax. Once you register, you will receive a business license and tax registration certificate.

In addition, you may be required to obtain the following, based on your business activities:

  • A seller's license from the state you live in.
  • An operation license, for a profession that requires one.
  • A zoning permit from your local zoning board.
  • Registration for the name of your business, if it differs from your own name.
  • An employee identification number (EIN) from the Internal Revenue Service — but only if you have employees, if you have a certified retirement plan, or if you pay excise taxes.

If you choose to use a fictitious name — often referred to as a DBA (doing business as) — for your business, you might have to register that name in your state or a local agency. Just keep in mind that your DBA is not the legal name for your business. Your name is the legal name for the business.

Steps to Meet Legal Requirements to Start a Sole Proprietorship

Even though a sole proprietorship forms as soon as you begin business activities, there are several important legal requirements to start a sole proprietorship and operate it lawfully. These steps vary by state but typically include:

  1. Choose and Register a Business Name
    • You may operate under your legal name or adopt a trade name (DBA).
    • If you use a DBA, most states require registration with the county clerk or state agency. Some states, like Georgia, also require publishing a notice of the DBA in a local newspaper.
  2. Obtain Licenses, Permits, and Zoning Approvals
    • Many businesses require local or state business licenses, such as seller’s permits for retail sales, or professional licenses for regulated fields.
    • Check zoning regulations to ensure your business location complies with local land-use rules.
  3. Apply for an Employer Identification Number (EIN), if Necessary
    • An EIN is required if you hire employees, create a retirement plan, or must pay excise taxes.
    • Even if not mandatory, an EIN is useful for opening a business bank account and separating personal from business finances.
  4. Register for State and Local Taxes
    • Depending on your state, you may need to register for sales tax, use tax, or employer withholding tax.
    • All earnings must be reported on your personal tax return, typically using IRS Schedule C attached to Form 1040.
  5. Maintain Compliance
    • Some states and municipalities require periodic renewal of licenses and permits.
    • Failure to comply with licensing or tax rules may result in penalties or forced closure.

What You Must Also Consider When Creating a Sole Proprietorship

Ultimately, you will need to be careful because you will have added responsibilities regarding the following: debts, taxes, and lawsuits. You will need to conduct yourself professionally and obey the law.

  • Regarding Debt: You are entirely responsible for any debts incurred by your business.
  • Regarding Taxes: Legally, you and your sole proprietorship are one and the same, so your business is a “pass-through” entity with regard to paying taxes. However, you must do the following to comply with tax law:
    • Report all earnings and expenses connected to your business if they total more than $400.
    • Fill out a 1040 tax return with a Schedule C form.
    • Pay a self-employment tax, which includes payments to Social Security and Medicare.
    • Pay your taxes during each quarter (every three months during the year).
    • If you happen to own more than one sole proprietorship, you only have to report your taxes once a year.
  • Regarding Lawsuits: If you failed to pay a supplier, default on a debt, or you lose a lawsuit, the person you owe can take your personal assets, like your home. To protect against these losses, you are encouraged to buy liability insurance.

Financial Management and Risk Protection

Sole proprietorships merge personal and business finances, which can create confusion if records are not carefully maintained. To help mitigate risks and stay compliant:

  • Separate Business and Personal Finances: Opening a business bank account under your DBA and EIN helps clearly track business income and expenses. This also makes it easier to claim deductions and prepare tax returns.
  • Liability Insurance: Because owners are personally liable for business debts and legal claims, many sole proprietors purchase general liability or professional liability insurance. Additional policies, such as property or auto insurance, may be necessary depending on your operations.
  • Business Planning: Drafting a business plan can help clarify goals, forecast expenses, and prepare for financing needs. Even though not legally required, this step is strongly recommended for long-term success

Advantages and Disadvantages of Owning a Sole Proprietorship

While you consider starting a sole proprietorship, you must weigh the benefits and drawbacks of such a business.

Advantages:

  • It is very easy to create a proprietorship.
  • The business grants you a great deal of flexibility.
  • You have more control over your business than you would have if you ran a full-fledged company.
  • You will not have to keep business records— but you should keep financial records to comply with taxes.

Disadvantages:

  • Sole proprietorships are more likely to fail because they often start with no preparation or planning.
  • As mentioned above, you will be personally liable for any losses, debts, or injuries connected to your business.
  • If you get married, extra property laws apply.
  • Unfortunately, a sole proprietorship dies with the owner, so the business cannot be inherited — unless a will specifies what happens to assets connected to the business.

Frequently Asked Questions

1. Do I need to file paperwork with the state to start a sole proprietorship?

No. Sole proprietorships are created automatically when you begin doing business. However, you may need to register a trade name, apply for licenses, and comply with tax rules.

2. Is an EIN required for sole proprietors?

Not always. Sole proprietors without employees can use their Social Security number for taxes. An EIN is required if you hire employees or pay excise taxes.

3. What taxes do sole proprietors pay?

You must report all income on your personal tax return using Schedule C. You’ll also owe self-employment tax for Social Security and Medicare.

4. How much does it cost to start a sole proprietorship?

There are no state filing fees to create a sole proprietorship. Costs come from local license fees, DBA registration, or publication requirements.

5. Can a sole proprietorship be passed on after death?

No. Sole proprietorships are tied to the owner and dissolve upon their death, unless assets are transferred through a will or estate plan.

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