Key Takeaways

  • A proprietorship is the simplest and most common business structure, owned and operated by one individual.
  • Sole proprietors report business income on their personal tax returns and are personally liable for all business debts.
  • No formal incorporation or registration with the state is typically required, though local permits and DBA registration may apply.
  • This structure offers ease of formation and complete control but lacks liability protection and may face funding challenges.
  • Proprietors are responsible for self-employment taxes, business licenses, and industry-specific regulations.
  • Transitioning to an LLC or corporation is common as the business grows to reduce risk and improve tax flexibility.

What is a Proprietorship?

Do you know what a proprietorship is? A proprietor is an owner of any business establishment, regardless of the type of business it is—be it a bookstore, pizza place, or contracting business. Proprietorship is thus the same as ownership when it comes to a business. Are you a proprietor? Are you considering becoming one? Regardless of where you are on your journey, it's important to understand the subtle nuances of having and operating a sole proprietorship.

Benefits and Drawbacks of a Proprietorship

A proprietorship is often the go-to choice for new entrepreneurs due to its simplicity and minimal startup costs. However, while this structure is appealing for its ease of operation, it comes with significant considerations.

Advantages of a Proprietorship:

  • Easy Formation: Little to no formal paperwork is needed to start.
  • Complete Control: The owner makes all decisions independently.
  • Tax Simplicity: Business income is reported on the owner’s personal tax return, eliminating the need for separate business filings.
  • Low Cost: There are no incorporation fees or required annual filings.
  • Flexible Management: No board meetings or corporate governance required.

Disadvantages of a Proprietorship:

  • Unlimited Liability: The owner is personally liable for all business debts and obligations.
  • Limited Funding: Investors often prefer incorporated businesses.
  • No Perpetuity: The business typically dissolves upon the owner’s death or decision to stop operating.
  • Harder to Scale: As operations grow more complex, the lack of legal separation can be risky.

Proprietorship Registration

Before any business can begin, it must first be registered. To register as a proprietorship, your business must be a small business that is expected to stay approximately the same size throughout its lifetime, and which is also not expected to last as long as a corporation.

Licensing and Legal Requirements for Proprietorships

While registering a proprietorship doesn’t usually involve filing with the state, you may still need to meet other legal requirements to operate legally:

  • Fictitious Business Name (DBA): If operating under a name other than the owner’s legal name, registration of a DBA with the appropriate county or state agency is necessary.
  • Licensing: Depending on the business type and location, you may need local business licenses, professional licenses, or permits (e.g., health, zoning).
  • Zoning Compliance: Ensure your business complies with local zoning laws, especially for home-based operations.
  • Employer Requirements: If you hire employees, you must obtain an Employer Identification Number (EIN) and comply with employment laws.

Contact the IRS for information on obtaining an EIN, or consult with a tax advisor to ensure compliance.

About Sole Proprietorship

Also called a sole trader or a proprietorship, Sole Proprietorship is a business that is not incorporated< and that is also not legally separated from its owner. In the United States, despite the fact that it does not offer limited liability, sole proprietorships are the most highly used legal structures for businesses.

A sole proprietorship is a business that is owned by only one person, and which does not have to be registered with the state, which is quite unlike an LLC or corporation which does. Anyone can establish a sole proprietorship, and in many cases, it doesn’t even involve any paperwork. It’s definitely, as far as businesses go, probably the easiest one to run and operate, especially when doing its taxes and balancing its books. Unlike an LLC, should a sole proprietorship fall into debt it is the owner’s responsibility to settle them.

The business owner doesn’t have to operate his or her business under his or her own name. If they want, they can create a new name that then becomes the name of the business. When this happens, though, the fictitious ‘identity’ is still not separate from the sole proprietor, and is not a legal loophole the owner can utilize so that he or she won’t be liable.

All that is really needed is to register his or name with the state and county, and get any licenses that may be needed (depending on the type of business).  After that, the owner is then ready for business.

The owner is not separated from his or her business. The two are legally linked. When checks are written out to the owner, even if they are written out to a fictitious name, the money will go to the owner’s bank account. Generally, sole proprietors combine business with personal properties and money. This, in contrast, is something that LLCs and corporations can’t do.

Sole proprietors can be sued for things that happen at his or her business. Because of this liability, businesses that begin as sole proprietorships will usually opt to a different legal structure once more money begins to come, and the business takes root. Most in these situations tend to transition to either an LLC or S-corporation.

Also, worth noting is:

  • Whenever the business takes in a profit or loss, so too does the owner.
  • Whether he or she takes in money or not, the income must be reported on tax form ‘schedule C,’ a form that should be filed with a 1040.
  • The ‘bottom-line amount’ is reported on the owner’s personal tax return.
  • Owners need to also file a ‘Schedule SE’ with their 1040, which calculates how much self-employment tax they need to pay quarterly.

In addition to paying income taxes, businesses need to pay sales taxes on any goods that are taxable, plus property taxes on any land the business operates from. Should the business tank and go under, sole proprietors are not able to collect any unemployment checks from the government. It is suggested that anyone considering starting a sole proprietorship know what could happen to them should anything bad happen. True, there is no reward without risk, but being completely liable for a business that may not do well may be cause enough to rethink one’s game plan.

When to Consider a Different Business Structure

While a proprietorship offers simplicity, it’s not always the best long-term structure. You may want to consider transitioning to an LLC or corporation if:

  • You’re seeking limited liability protection to safeguard personal assets.
  • Your business is generating increasing revenue and growth potential.
  • You want to attract investors or partners, which is easier with formal structures.
  • You're interested in tax flexibility, such as electing S corporation status.
  • You require a more credible professional image with clients or suppliers.

A legal professional can help evaluate whether it's time to convert your proprietorship into a more complex entity. You can find experienced business attorneys through UpCounsel to help you navigate this process.v

Tax Obligations and Filing for Sole Proprietors

Sole proprietors report all income and losses from the business on their personal tax returns using Schedule C (Form 1040). Key tax responsibilities include:

  • Income Tax: All business income is treated as personal income.
  • Self-Employment Tax: Proprietors pay Social Security and Medicare taxes via Schedule SE.
  • Estimated Taxes: Quarterly estimated payments are often required to avoid penalties.
  • Sales Tax: If selling taxable goods or services, you must collect and remit state sales tax.
  • Payroll Tax: If you hire employees, you’re responsible for withholding and paying payroll taxes.

Even though a sole proprietorship is not a separate tax entity, maintaining accurate records is crucial. Business and personal expenses should be tracked separately to avoid IRS scrutiny.

Frequently Asked Questions

1. Do I need to register my proprietorship with the state? No, most states do not require registration for sole proprietorships, though you may need a DBA or local business license.

2. Can I hire employees under a sole proprietorship? Yes, you can hire employees, but you must obtain an EIN and follow all payroll tax and labor laws.

3. What taxes do I pay as a sole proprietor? You’ll pay income tax on all profits and self-employment tax for Social Security and Medicare. You may also be responsible for sales tax and other local taxes.

4. How do I name my proprietorship? You can use your legal name or register a Doing Business As (DBA) name with your local government.

5. Can a proprietorship be transferred or sold? A proprietorship cannot be transferred as a whole entity, but its assets and operations can be sold to another person who would then run it as their own business.

If you need help learning more about proprietorship, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.