What is a sole proprietorship? A guide to getting started

Published Wednesday 20 May 2026

Table of contents

• What is a sole proprietorship?
• Who should consider a sole proprietorship?
• How to set up a sole proprietorship
• Advantages of a sole proprietorship
• Disadvantages of a sole proprietorship
• Protecting yourself as a sole proprietor
• Tax requirements for sole proprietors
• Sole proprietorship vs other business structures
• Simplify your sole proprietorship finances with Xero
• FAQs on sole proprietorships

Key takeaways

• A sole proprietorship is the simplest business structure in the US, with no formal registration required to get started, making it a popular choice for freelancers, consultants, and side hustlers.
• You and your business are legally the same entity, which means you're personally responsible for all debts and obligations. Business insurance and separating your finances can help reduce that exposure.
• Sole proprietors report business income on their personal tax return using Schedule C, and pay a 15.3% self-employment tax covering Social Security and Medicare contributions.
• As your business grows, you can convert to an LLC or corporation to gain liability protection and potential tax advantages without starting from scratch.

What is a sole proprietorship?

A sole proprietorship is an unincorporated business owned and operated by one 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.

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.

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.

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 $100.

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 one.

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 corporations.
• 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 can't continue independently if you become incapacitated or pass away, since it's tied directly to you.
• 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.

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.
• 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.

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.

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 $50 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

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.

Get one month free and see how Xero can simplify your financial management from day one.

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. You can apply for free on the IRS website.

What are the pros and cons of a sole proprietorship?

The main advantages are simplicity, low cost, and full control over your business. On the downside, you're personally liable for all debts and legal claims, and you may have fewer options for raising capital or reducing your tax burden compared to an LLC or S-corp.

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. Many sole proprietors also work with independent contractors, which involves different tax reporting requirements.

What is an example of a sole proprietorship?

A freelance graphic designer who works independently under their own name is a common example. Other examples include a personal trainer, a lawn care provider, an independent consultant, or someone selling handmade products online. If you're the sole owner and haven't formed a separate legal entity, you're operating as a sole proprietor.

How much does it cost to start a sole proprietorship?

The cost to start is minimal. If you operate under your legal name, there are no mandatory registration fees. Filing a DBA typically costs $10 to $100, and business licenses or permits vary by location and industry. Beyond that, your main costs are whatever you need to actually run the business.

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 (or apply for a new one), transfer business assets, and notify your bank, clients, and vendors of the change. The process is straightforward and doesn't require you to shut down your existing business first.