What is a sole proprietorship?

A sole proprietorship is an unincorporated business owned and operated by 1 person, with no legal distinction between the owner and the business. It's the simplest and most common business structure in the United States.

The Internal Revenue Service (IRS) doesn't require you to file any special forms to create one. If you're the only owner of a business and haven't registered as another entity type, the IRS automatically classifies you as a sole proprietor. You report all business income and expenses on your personal tax return.

In practice, this means you have full control over every business decision, from pricing to daily operations. You keep all the profits, but you also take on all the financial and legal responsibility.

It's worth noting that being a sole proprietor isn't the same as being self-employed, though the terms often overlap. "Self-employed" is a broad category that includes sole proprietors, independent contractors, and freelancers. A sole proprietorship is specifically the legal and tax classification the IRS assigns to an unincorporated business with 1 owner.

Sole proprietor vs independent contractor

These 2 terms cause a lot of confusion, but they describe different things. A sole proprietorship is a business structure and tax classification. An independent contractor is defined by a work relationship: you provide services to clients under a contract rather than as an employee.

In practice, most independent contractors are sole proprietors by default, because they haven't formed an LLC or corporation. But not every sole proprietor is an independent contractor. You could run a retail shop, sell products online, or operate a food truck as a sole proprietor without contracting services to anyone. The key distinction is that "sole proprietorship" describes how your business is organized, while "independent contractor" describes how you work with clients.

Who should consider a sole proprietorship?

A sole proprietorship works well if you're running a straightforward, low-risk business on your own. It's especially common among people who want to start quickly without dealing with complex paperwork or upfront costs.

You might be a good fit for a sole proprietorship if you're:

A freelancer or independent contractor offering services like writing, design, or consulting
A tradesperson such as a plumber, electrician, or landscaper working independently
Running a home-based business like tutoring, baking, or crafting
Starting a side hustle alongside a full-time job
Testing a new business idea before committing to a more formal structure

If your business involves significant financial risk, multiple owners, or plans to raise outside investment, a different structure like an LLC or corporation may be a better starting point.

Types of sole proprietorships

Not all sole proprietorships look the same. While the legal structure is identical, the way you operate and present your business can vary. Here are the 3 most common types.

General sole proprietorship: you operate under your own legal name with no additional registrations. This is the default when you start earning business income as an individual.
DBA (doing business as) sole proprietorship: you register a trade name with your state or county and operate under that name instead of your own. This is common for businesses that want a distinct brand identity, like "Bright Side Bakery" instead of "Jane Smith."
Licensed professional sole proprietorship: certain professions, such as attorneys, certified public accountants (CPAs), doctors, and real estate agents, can operate as sole proprietors while holding a professional license. These businesses may be subject to additional regulatory requirements specific to the profession.

Regardless of which type applies to you, the tax treatment and legal structure remain the same. You're still personally liable for the business, and income flows through to your personal tax return.

How to set up a sole proprietorship

Getting started as a sole proprietor is more straightforward than forming an LLC or corporation. While there's no single federal registration process, you'll still need to take a few steps depending on your state and industry.

1. Choose and register your business name

You can operate under your legal name without any registration. If you'd prefer a different business name, you'll need to register a "doing business as" (DBA) name with your state or county.

A DBA lets you open a business bank account, accept payments, and market your services under a professional brand name. It doesn't create a separate legal entity or provide liability protection; it simply links a trade name to you as the owner.

Before filing, search your state's business name database and the US Patent and Trademark Office to confirm the name isn't already taken. DBA registration fees vary by state but typically range from $10 to $150. Some states require you to renew your DBA every few years, so check your local requirements.

2. Get required licenses and permits

Depending on your location and industry, you may need federal, state, or local licenses and permits to operate legally. For example, food-based businesses often need health department permits, while home-based businesses may need a zoning permit.

Check with your city or county clerk's office and your state's business licensing agency to find out what applies to you. The Small Business Administration (SBA) also maintains a directory of state-specific requirements.

3. Get an employer identification number (EIN)

An employer identification number (EIN) is a federal tax ID issued by the IRS. You're required to get one if you plan to hire employees, open certain business bank accounts, or file excise tax returns.

Even if it's not required, an EIN can help you keep your Social Security number private on business documents. You can apply for free on the IRS website, and you'll receive your number immediately.

4. Open a business bank account

Keeping your personal and business finances separate makes it much easier to track income, manage expenses, and prepare for tax season. A dedicated business bank account also looks more professional to clients and vendors.

Most banks require your DBA registration (if applicable), your EIN or Social Security number, and a form of personal identification to open a business account.

5. Set up your accounting and record keeping

Tracking every dollar that comes in and goes out is essential for filing accurate tax returns and understanding how your business is performing. Keep receipts, invoices, and bank statements organized from day 1.

Cloud accounting software like Xero can simplify this by automatically importing bank transactions, categorizing expenses, and generating reports. Setting up a reliable system early saves you time and stress when tax deadlines arrive.

Advantages of a sole proprietorship

A sole proprietorship offers several practical benefits, especially for new and small business owners who want to keep things simple and affordable.

Easy to start. There's no formal registration with the state, no articles of incorporation, and no operating agreements to draft.
Low cost. Startup expenses are minimal since you don't pay formation fees, franchise taxes, or annual report charges that other structures require.
Full control. You make every business decision on your own without needing approval from partners, a board, or shareholders.
Simple taxes. Business income passes through to your personal tax return, so you avoid the double taxation that can apply to C-corporations.
All profits are yours. There's no separate business income tax return required, and you don't need to split earnings with partners or distribute dividends to shareholders.
No partner or shareholder complications. You control when, whether, and how the business continues, without navigating co-owner disagreements or buyout scenarios.
Fewer compliance requirements. You won't need to hold annual meetings, file annual reports, or maintain corporate minutes.
Easy to close. If you decide to stop operating, you can wind down the business without formal dissolution paperwork in most states.

Disadvantages of a sole proprietorship

While a sole proprietorship is the easiest structure to set up, it does come with some trade-offs worth understanding before you commit.

Unlimited personal liability. You're personally responsible for all business debts and legal claims, which means your personal assets, including your home and savings, could be at risk.
Harder to raise capital. Banks and investors often prefer to work with formally registered entities like LLCs or corporations, which can make it harder to secure funding.
Self-employment taxes. You'll pay the full 15.3% self-employment tax on your net earnings, covering both the employer and employee portions of Social Security and Medicare.
Limited business continuity. The business doesn't survive the owner: a sole proprietorship legally dissolves if you die or become incapacitated. Unlike an LLC or corporation, it can't be transferred or inherited as a going concern.
No built-in peer support. Working alone means there are no partners, co-founders, or management team to share the workload or decisions with.
Fewer tax planning options. Unlike S-corps or LLCs taxed as S-corps, you can't split income between salary and distributions to potentially lower your tax burden.

The financial headwinds are real. According to Xero Small Business Insights, US small businesses averaged just 2.4% sales growth in 2025, about half the long-term average of 5.5%, even as nominal GDP grew at 5.1%. That gap between Main Street and headline economic indicators can make it harder to demonstrate the financial track record lenders and investors look for.

Protecting yourself as a sole proprietor

Since a sole proprietorship doesn't provide built-in liability protection, taking proactive steps to safeguard your personal assets is especially worthwhile. This guide to small business insurance covers your options in detail.

Here are some practical ways to reduce your exposure:

Get general liability insurance. This covers claims related to bodily injury, property damage, and advertising injury that could arise from your business activities.
Consider professional liability insurance. If you provide professional services or advice, this protects you against claims of negligence, errors, or omissions. You might also look into an umbrella liability policy or business owner's policy (BOP) for broader coverage.
Separate personal and business finances. Use a dedicated business bank account and credit card so your personal assets aren't mixed in with business transactions.
Use written contracts. Clearly define the scope of work, payment terms, and liability limits in every client or vendor agreement.
Review your structure regularly. If your revenue grows significantly or your liability risk increases, switching to an LLC or corporation can give you a layer of legal protection that a sole proprietorship doesn't offer.

Cash flow timing is another reason financial separation matters. Xero Small Business Insights data shows US small businesses waited an average of 27.9 days to be paid in late 2025, with invoices arriving 7.8 days past due on average. A dedicated business bank account makes it easier to track what's outstanding and what's available, giving you better visibility for managing your cash flow without mixing business funds with personal ones.

Tax requirements for sole proprietors

As a sole proprietor, your business income is taxed as personal income. You'll file a few specific IRS forms and should plan for quarterly payments to avoid penalties.

Here are the key tax obligations to be aware of:

Schedule C (Form 1040). You'll report all business income and expenses on Schedule C, which is filed alongside your personal tax return.
Schedule SE. This form calculates your self-employment tax, which is 15.3% of your net earnings (12.4% for Social Security and 2.9% for Medicare).
Quarterly estimated taxes. If you expect to owe $1,000 or more in taxes for the year, the IRS requires you to make estimated payments using Form 1040-ES. These are due in April, June, September, and January.
Deductions. You can deduct ordinary and necessary business expenses, including home office costs, supplies, mileage, health insurance premiums, and retirement contributions. Tracking these throughout the year can significantly reduce your taxable income. A detailed list of eligible write-offs is available in this guide to tax deductions.
Record keeping. The IRS requires you to maintain records that support your income and deductions. Keep receipts, bank statements, and invoices for at least 3 years from the date you filed the return (longer in some cases, such as 6 years if income is substantially underreported).

Famous examples of sole proprietorships

Some of the world's biggest companies started as sole proprietorships, which says a lot about where a simple business structure can take you.

Jeff Bezos started Amazon in 1994 by selling books out of his garage in Bellevue, Washington, before formally incorporating the company later that year. Pierre Omidyar started what would become eBay in 1995 as a personal project, listing a broken laser pointer as his first auction item, before incorporating as the business grew. Both founders began with small, solo operations before scaling into larger business structures.

These examples don't mean every sole proprietorship will become a global brand. But they show that starting small and simple doesn't limit your long-term potential. Many successful businesses begin with 1 person, 1 idea, and the flexibility to grow at their own pace.

Sole proprietorship vs other business structures

Choosing the right business structure affects your taxes, personal liability, and ability to grow. Here's how a sole proprietorship compares to the most common alternatives. For a broader overview, see this guide to types of business structures.

Sole proprietorship vs LLC

A limited liability company (LLC) separates your personal assets from your business liabilities, which a sole proprietorship doesn't do. For a deeper comparison, see sole proprietor vs LLC.

Key differences include:

Liability: an LLC protects your personal assets from business debts and lawsuits. A sole proprietorship offers no such protection.
Taxation: both are pass-through entities by default, meaning profits are taxed on your personal return. However, an LLC can elect to be taxed as an S-corp for potential savings.
Formation: an LLC requires filing articles of organization with your state and paying a formation fee, typically $35 to $500. A sole proprietorship has no formation requirements. Learn more about what an LLC is and how to form one.
Ongoing compliance: many states require LLCs to file annual reports and pay franchise or renewal fees.

Sole proprietorship vs partnership

If you're going into business with at least 1 other person, a partnership is the default structure. Here's how they differ:

Ownership: a sole proprietorship has 1 owner. A partnership requires 2 or more owners.
Liability: in a general partnership, each partner is personally liable for the business's debts, including those created by the other partner.
Taxation: both are pass-through entities. A partnership files an informational return (Form 1065) and issues Schedule K-1 to each partner.
Formation: partnerships should have a written partnership agreement, though it isn't legally required in all states.

Sole proprietorship vs S-corp

An S-corporation (S-corp) is a tax election, not a separate business structure. You can form an LLC or corporation and then elect S-corp status with the IRS. This guide on S-corp vs LLC explains the nuances in more detail.

Differences include:

Liability: an S-corp provides personal asset protection. A sole proprietorship doesn't.
Taxation: S-corp owners who work in the business pay themselves a "reasonable salary" and can take additional profits as distributions, which aren't subject to self-employment tax.
Formation: an S-corp requires forming an LLC or corporation first, then filing Form 2553 with the IRS.
Compliance: S-corps must run payroll, file separate tax returns, and meet stricter record-keeping requirements.

Sole proprietorship vs corporation

A corporation (C-corp) is the most formal business structure and is designed for businesses that plan to scale, raise investment, or go public. Here's how they compare:

Liability: a corporation provides the strongest personal liability protection.
Taxation: C-corps face double taxation; the company pays corporate income tax, and shareholders pay personal income tax on dividends. Sole proprietors pay tax only once, on their personal return.
Formation: incorporating requires filing articles of incorporation, creating bylaws, and issuing stock.
Ownership: corporations can have unlimited shareholders, making it easier to raise capital through equity.

When to switch to a different structure

Your sole proprietorship may not be the right fit forever. Consider switching when:

Your personal liability exposure grows beyond what insurance can reasonably cover
Your net self-employment income is high enough that S-corp tax treatment would save you money
You want to bring on a business partner
You're seeking outside investment or a business loan that requires a formal entity
Your state offers specific benefits, such as charging orders protection, for LLCs

Converting from an LLC back to a sole proprietorship

If you formed an LLC but find that the ongoing compliance requirements and fees aren't worth it for your situation, you can convert back to a sole proprietorship.

The process involves formally dissolving your LLC with your state, which typically requires filing articles of dissolution and paying any outstanding fees. Once the LLC is dissolved, you automatically revert to operating as a sole proprietor if you're the only owner. You'll also need to update your business bank accounts, contracts, and tax filings to reflect the change. Keep in mind that dissolving your LLC means you lose its liability protection, so make sure you have adequate insurance in place before making the switch.

Simplify your sole proprietorship finances with Xero

Running a sole proprietorship means you're handling finances on top of everything else. Xero's cloud accounting software helps you stay on top of invoicing, expense tracking, bank reconciliation, and tax preparation, so you can spend less time on bookkeeping and more time growing your business.

Whether you're tracking deductions for Schedule C or keeping tabs on who's paid and who hasn't, Xero keeps your numbers organized and accessible from anywhere. Get one month free and see how Xero can simplify your financial management from day 1.

FAQs on sole proprietorships

Here are some frequently asked questions about sole proprietorships to help you get started with confidence.

Do sole proprietors need an EIN?

You're not required to have an EIN if you don't have employees and don't file excise tax returns. However, many sole proprietors get one to keep their Social Security number private and to open a business bank account more easily.

What is the difference between a sole proprietor and an independent contractor?

A sole proprietorship is a business structure, while an independent contractor is defined by a work relationship with clients. Most independent contractors operate as sole proprietors by default, but a sole proprietor can also run a retail shop or sell products without contracting services.

Can a sole proprietorship have employees?

Yes, sole proprietors can hire employees. You'll need to get an EIN, register for state employer taxes, set up payroll, and comply with federal and state labor laws.

How much is self-employment tax for a sole proprietor?

The self-employment tax rate is 15.3% of your net earnings, covering 12.4% for Social Security and 2.9% for Medicare. You calculate this using Schedule SE, which you file alongside your personal tax return.

What is a DBA and do I need one for my sole proprietorship?

A DBA ("doing business as") is a registered trade name that lets you operate under a name other than your own legal name. You need one if you want to brand your business, open a bank account under a business name, or accept payments under a trade name.

Can you convert a sole proprietorship to an LLC?

Yes, you can convert at any time by filing articles of organization with your state and paying the required fee. You'll also want to update your EIN, transfer business assets, and notify your bank, clients, and vendors of the change.

Disclaimer

This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.

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