What is a Sole Proprietorship?

A sole proprietorship is a business with a single owner. It is the dream for many people. These businesses, which are not registered as an LLC (limited liability company), a partnership, or a corporation, have the benefit of flexibility. Sole proprietors can work as freelancers — independent contractors — or they can run physical, on-the-ground businesses. 

Often, home-based businesses are sole proprietorships. There are 23 million of these in operation today, vastly more than any other traditional forms. This sort of business carries dangers with it, and it's important to understand them so you can avoid pitfalls in bookkeeping, taxes, and other potential liabilities.

Sole Proprietorship vs. Incorporated Business

There's one major difference between a sole proprietorship and a registered or incorporated business. With a sole proprietorship, there's no separation between the business and the owner. The two are the same, which means that any liabilities or debts the business builds, the owner is responsible for. That puts your personal assets at stake if you run into business troubles. 

In a sole proprietorship, you don't have to have shareholder meetings or a board of directors to vote on major business decisions. The company is yours, and every decision starts and ends with you. You sign your own checks, sign contracts with your name, and conduct all legal and professional dealings under your own identity. While your business may have a DBA or fictitious name, you are the one responsible for all operations.

Why Choose a Sole Proprietor Business?

The primary advantage that makes this kind of business attractive is that it's easy to set up. You don't even have to register a name. Just operate under your own name, or pick a name, choose a location, and get up and running. Many people set up a business checking account, but you don't even have to do this.

Filing Taxes

The proprietorship doesn't require separate business taxes to be filed. They are simply reported on your personal taxes using Schedule C on Form 1040 in the U.S. or the TI tax form in Canada. In addition, if your business is home-based, you can deduct all business-related expenses, and any losses your business suffers count as deductions. 

The Small Business Administration (SBA) reports that tax rates for a sole proprietorship are lower than any other form of business at 13.3 percent, compared to the 26.9 percent that S corporations pay. 

LLCs with only one member might pay sole prop taxes, whereas LLCs with multiple members pay taxes as partnerships. In partnerships, any income is taxed at the personal tax rates of the partners, and in corporations, shareholders pay business taxes at corporate rates. 

The Risks of Doing Business

Of course, the lack of separation between personal and business expenses and assets creates some risks. Unlike with a registered corporation, you don't enjoy limited liability, which separates any business problems from the individual.

You can be held responsible for any damages from lawsuits, failed business ventures, or other problems. You also have less flexibility in tax reporting with a proprietorship business. If you file bankruptcy, even Chapter 11 reorganization, that means putting your house, car, and other personal assets on the line. 

Other problems with this kind of venture include potential difficulty landing jobs and raising capital, as many will not contract with an unincorporated business. Venture capitalists, angel investors, and other entities see a risk in the lack of separation between person and business. There's a perception of a lack of professionalism in single-owner, unincorporated businesses. 

Finally, when you want to get out of your business, even if you get a great offer, it can be difficult and tricky to sell an unincorporated business. It is hard to value your business when it's tied to your personal assets. In addition, when you pass away, the business is simply worthless and just ends, with nothing left for your descendants or heirs. 

Common Forms of Sole Proprietorship

An infinite number of businesses function as a sole proprietorship but consider these common examples.

  • Accountant: An accountant or bookkeeper helps other businesses keep financial records; tracking expenses, profits, revenue, payments, and other financial data for accounting purposes. This helps businesses accurately file taxes every year and keeps an accurate record of their finances.

  • Caregiver: There's always a need for health care providers in-home. These businesses often cater to seniors and include not just medication and medical needs, but companionship, hygiene, cleaning, cooking, and daily tasks.

  • Financial Planning: Financial planners help people with end-of-life decisions like wills and estates, or with business formation and exit plans, retirement, college savings, investments, and other major financial events.

  • Landscaping: Landscaping businesses help people keep their yard looking beautiful and do everything from planting flowers to cutting the grass to re-terracing and shaping the land. They might employ a number of workers.

  • Computer Repair: These companies are often run by a single person working out of the home troubleshooting hardware and software problems for clients and keeping computers running like new.

  • Housekeeping: Housekeeping services, which travel around to clean and organize homes, are often single-owner affairs, though like landscapers they may hire several employees.

  • Freelancer: Freelance writers, artists, and graphic designers make a living plying their art on a sole proprietor basis, taking on jobs as a contractor or starting companies of their own.

  • Tutors and Trainers: Tutors help with everything from difficulty with math homework to corporate training in best practices and sensitivity seminars.

  • Virtual Assistants: These administrative professionals work to help business owners and executives take care of administrative needs through the internet, from answering email to drafting documents to record keeping and more.

A Jumping-Off Point

Many people view the sole proprietorship as a jumping-off point. They begin their business this way and then incorporate later when they're ready. There's no legal requirement for your business to stay in the same form for its entire lifespan. It's possible for a sole proprietorship to change over time. For example, many small businesses are founded as sole proprietorship and then alter their legal structure after experiencing growth. This is the exact situation that happened to Kate Schade, founder of Kate's Real Food.

Schade started here business as a sole proprietorship in Victor, Idaho so that she could create and sell energy bars as a local vendor. The proprietorship then expanded to a few customers in Jackson, local farmer's markets, and online sales. Since that time, Kate's Real food has expanded to the point that it now sells its energy bars nationwide. To promote this growth, Kate Schade restructured here proprietorship to a corporation. This allowed the business to expand and accept investments.

When restructuring to an LLC, make sure your business name is not in use by someone else, and then file the proper paperwork with the state. The exact documents to file and the office where you need to file them vary by state. You then need to acquire an EIN or employment identification number. This is for a business what your social security number is for your personal taxes. You get this number from the IRS.

Starting a Sole Proprietorship

Starting a sole proprietorship business is a pretty basic process. The first step is to have an idea for a product or service you want to sell. You need to devote the necessary time and work into your startup and learn about proper business practices and accounting principles.

There are no formal legal steps required to register a sole proprietorship business. Just by conducting business, you're already a business owner. Some cities and municipalities require you to register your business with the local government or get an occupancy license, as well as potentially paying local business tax. Contacting your local SBDC (small business development center) office is of great use in this area.

Next, choose a name, register the web domain for it, and, if your business name is different from your name, register it as well to keep other people using it. The moment you start using this business name in commerce you can mark it with a Trademark symbol ™.  If you wish to register the trademark for more protection, check out the USPTO website resources.

Running your business under a name other than your own is called "DBA," or "Doing Business As."

Separating Finances

When you work as a sole proprietorship, even though your personal and business assets intertwine, you want to separate your financial activities. This is of great use when you prepare your tax returns and financial statements, as your business assets and losses have a major impact on your taxes.

Because of this, you want to set up a business bank account that's only for your business activities, get a business credit card, and acquire software to track your business records. Keep your business finances as separate as possible from your personal activities.

This matters because for the first several years of your business, you suffer a lot of losses that are 100 percent deductible. You have to pay self-employment taxes after you start making a profit, which is done quarterly based on your estimated taxes. If you're selling products, you may have to pay sales tax based on your local rates.

Insurance Concerns

Besides tax liabilities, the single greatest risk to the owner of a sole proprietorship is legal liability. In order to protect yourself from accidents, unforeseen circumstances, and lawsuits, get a solid insurance policy. There are several types of business insurance you may want to consider.

  • Auto Insurance: if you plan to use your personal vehicle for business purposes, you want to extend your auto coverage for this purpose. Most insurance companies won't cover business use of personal vehicles without a proper policy add-on.

  • Property Insurance: Your homeowner's policy won't necessarily protect you if a disaster happens on your property while you're using it for business. Make sure that you have business coverage.

  • Liability Coverage: In addition, every business runs the risk of being sued for any number of things. The right liability coverage protects your personal assets should you be the target of a lawsuit.

  • Health Care: Unless you have health insurance through your spouse or through a former employer, you want to check out the Healthcare Marketplace or seek personal insurance another way. Also consider disability coverage since you won't have workers' compensation.

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