What is a sole proprietor? Taxes, liability, and how to start

Published Monday 15 June 2026

Table of contents

• What is a sole proprietor?
• Pros of sole proprietorship
• Things you should know about being a sole proprietor
• Sole proprietorship vs. LLC vs. partnership
• How to start a sole proprietorship
• Sole proprietorship taxes explained
• How to protect your personal assets as a sole proprietor
• Manage your sole proprietorship with Xero
• FAQs on sole proprietorships

Key takeaways

• A sole proprietorship is the simplest business structure in the US. You become one automatically when you start selling goods or services for profit without forming a limited liability company (LLC) or corporation, and there are no registration fees to get started.
• Unlimited personal liability is the biggest risk. Your personal assets, including your home, car, and savings, can be used to cover business debts or legal judgments against your business.
• Sole proprietors pay self-employment tax of 15.3% on net earnings, covering both the employee and employer portions of Social Security and Medicare. You'll also need to make quarterly estimated tax payments to the IRS.
• Separating your personal and business finances from day 1 makes bookkeeping, tax filing, and asset protection significantly easier. Apply for an Employer Identification Number (EIN) and open a dedicated business bank account.

What is a sole proprietor?

A sole proprietor is someone who owns and operates an unincorporated business by themselves. There's no legal separation between you and your business: you personally own all assets, earn all profits, and bear all liabilities.

It's the most common business structure in the US. According to Internal Revenue Service (IRS) data, roughly 31 million sole proprietor tax returns were filed in 2022, making it by far the most common business structure in the country. If you charge customers for goods or services with the intention of earning a profit, you're automatically considered a sole proprietor unless you've registered as an LLC or corporation.

Common examples of sole proprietors include:

• Freelance writers, graphic designers, and web developers
• Independent consultants and bookkeepers
• Contractors, electricians, and handypeople
• Personal trainers and yoga instructors
• Photographers, tutors, and rideshare drivers

As your business grows, you can reorganize into an LLC, S corporation, or C corporation. Learn more about other common small business structures: what is an LLC and what is an S corporation.

Here are some of the advantages of operating as a sole proprietor.

Pros of sole proprietorship

The sole proprietorship structure offers several benefits, especially if you're just starting out or testing a business idea.

It's easy to start

You become a sole proprietor the moment you start operating. There's no registration paperwork, no formation documents, and no waiting period. You can begin earning revenue right away.

Lower upfront costs

Unlike forming an LLC or corporation, there are no state filing fees or formation costs. Your only expenses might be a local business license or a DBA registration, which typically costs between $10 and $100 depending on your state or county.

Simpler tax filing

Tax filing is more straightforward for sole proprietors than for most other business structures. You report business income on Schedule C, which you attach to your personal tax return (Form 1040). There's no separate corporate tax return to file.

Full control over decisions

You make every decision for your business without needing approval from partners, a board, or shareholders. This speed and flexibility lets you respond quickly to opportunities and pivot when something isn't working.

Easy to dissolve

If you decide to close your business, there's no formal dissolution process. You stop operating, settle any remaining debts, and file your final tax return. Compare this to an LLC or corporation, where you'd need to file dissolution documents with the state.

Before starting a sole proprietorship, consider these important factors.

Things you should know about being a sole proprietor

While sole proprietorships are easy to start, they come with significant considerations that could affect your business and personal finances.

Your personal assets are at risk

Unlimited personal liability is the biggest risk of being a sole proprietor. If your business is sued or can't pay its debts, your personal assets, including your home, car, and savings, can be used to cover those obligations. Unlike an LLC, there's no legal barrier between your business and personal finances.

Business insurance and contracts with liability limitations can help reduce this risk. General liability insurance is a good starting point for most sole proprietors.

You'll pay self-employment tax

As a sole proprietor, you pay self-employment tax on your net earnings. This covers Social Security and Medicare. Unlike traditional employees who split these taxes with their employer, you pay both halves: currently 12.4% for Social Security and 2.9% for Medicare, totaling 15.3%.

You can deduct the employer-equivalent half (7.65%) from your taxable income, which reduces your overall tax burden. Still, self-employment tax is one of the largest expenses sole proprietors face.

You may need to restructure as you grow

A sole proprietorship can only have 1 owner. If you want to bring in partners, sell equity, or raise outside capital, you'll need to convert to a different business structure like an LLC or corporation.

Many business owners start as sole proprietors and explore other structures as their revenue and risk exposure grow.

Building business credit is harder

Since your business isn't a separate legal entity, lenders evaluate your personal credit when you apply for business financing. Keeping your personal credit score strong is especially important when you operate as a sole proprietor.

Sole proprietorship vs. LLC vs. partnership

Choosing the right business structure affects your personal liability, taxes, and growth options. Here's how sole proprietorships, LLCs, and partnerships compare across the areas that matter most.

Liability protection

• Sole proprietorship: no liability protection. Your personal assets are fully exposed to business debts and lawsuits.
• LLC: your personal assets are generally protected. The LLC creates a legal barrier between your business obligations and personal finances.
• Partnership: general partners have unlimited personal liability, similar to sole proprietors. Limited partners are only liable up to their investment.

Formation and cost

• Sole proprietorship: no formation paperwork or filing fees. You're one the moment you start operating.
• LLC: requires filing articles of organization with your state, paying a formation fee (typically $50 to $500), and maintaining annual filings or reports.
• Partnership: requires a partnership agreement (strongly recommended, though not always legally required) and may need state registration depending on the type.

Taxes

• Sole proprietorship: profits pass through to your personal tax return via Schedule C. You pay income tax plus 15.3% self-employment tax on net earnings.
• LLC: default tax treatment is the same as a sole proprietorship (single-member) or partnership (multi-member). An LLC can also elect S corp taxation for potential payroll tax savings.
• Partnership: profits pass through to each partner's personal tax return based on the partnership agreement. Partners pay self-employment tax on their share.

Ownership and growth

• Sole proprietorship: limited to 1 owner. You can't bring in partners or sell equity without changing your structure.
• LLC: can have 1 or more members. Flexible ownership structure that accommodates growth.
• Partnership: requires 2 or more owners by definition. Useful when you're launching a business with someone else from the start.

If you're running a low-risk business on your own, a sole proprietorship is often the right starting point. As your revenue, risk, or team grows, converting to an LLC gives you more protection and flexibility. Read more about sole proprietor vs. LLC differences.

Follow these steps to get your sole proprietorship up and running.

How to start a sole proprietorship

Starting a sole proprietorship requires no formal registration. You're automatically one when you begin operating for profit. These setup steps help you run your business smoothly from day 1.

1. Check permits and licenses

Verify whether your city, county, or state requires a business permit or license. Requirements vary widely by location and industry. Common types include:

• General business license: required by many cities and counties for any business operating within their jurisdiction
• Professional license: needed for regulated professions like accounting, real estate, cosmetology, and healthcare
• Zoning permit: confirms your business location (including a home office) complies with local zoning laws
• Sales tax permit: required if you sell taxable goods or services in your state
• Health and safety permit: necessary for food service, childcare, and similar businesses

Check with your state's business licensing office and your local city or county clerk's office to find exactly what you need.

2. Apply for an Employer Identification Number (EIN)

Get a free EIN from the IRS website. You'll need 1 to open a business bank account, hire employees, and file certain tax forms. An EIN also keeps your Social Security number private on business documents. The IRS limits applications to 1 EIN per day for each responsible party.

3. Choose a business name

By default, your sole proprietorship uses your legal name. To operate under a different name, register a "doing business as" (DBA) with your state or county. The process is typically simple and costs between $10 and $50 in most locations. To protect your business name nationally, you can register a trademark through the United States Patent and Trademark Office.

4. Open a business bank account

Separating personal and business finances simplifies bookkeeping and makes tax time easier. Your business bank statements become a clear record of income and expenses. Most banks require an EIN or DBA certificate to open a business checking account.

5. Set up your bookkeeping

Track every dollar coming in and going out from the start. Good records save you time during tax season and give you a clear picture of your business's financial health. Cloud accounting software can automate much of this by connecting directly to your bank account and categorizing transactions.

Once your business is running, understanding your tax obligations is the next priority.

Sole proprietorship taxes explained

Sole proprietors face a different tax situation than traditional employees. You're responsible for calculating, reporting, and paying your own taxes throughout the year.

Income tax and Schedule C

You report all business income and expenses on Schedule C, which you file with your personal Form 1040 return. Your net profit (revenue minus deductible expenses) flows directly to your personal tax return and is taxed at your individual income tax rate. According to the IRS, you must file if your net earnings are $400 or more.

Self-employment tax

On top of income tax, you'll pay self-employment tax of 15.3% on your net earnings. This covers Social Security (12.4%) and Medicare (2.9%). As a sole proprietor, you pay both the employee and employer portions. You can deduct the employer-equivalent half when calculating your adjusted gross income.

Quarterly estimated tax payments

Since no employer withholds taxes from your income, the IRS expects you to pay estimated taxes 4 times per year: in April, June, September, and January. If you underpay, you may owe a penalty when you file your annual return. A common approach is to estimate your annual tax liability and divide it into 4 equal payments.

Qualified business income (QBI) deduction

Many sole proprietors qualify for the QBI deduction, which lets you deduct up to 20% of your qualified business income from your taxable income. Income thresholds and limitations apply, so check IRS guidelines or consult a tax professional to confirm your eligibility.

Deductible business expenses

Tracking your expenses carefully can reduce your tax bill significantly. Common tax deductions for sole proprietors include:

• Home office expenses (dedicated space used exclusively for business)
• Business supplies, software, and equipment
• Vehicle mileage for business travel
• Health insurance premiums (if you're not eligible for an employer plan)
• Professional development, courses, and industry memberships
• Marketing and advertising costs

Keep receipts and records for every deduction. Cloud accounting software can simplify this by categorizing expenses automatically as they come in.

How to protect your personal assets as a sole proprietor

Without the legal separation an LLC provides, sole proprietors need to take deliberate steps to shield their personal finances from business risks.

Get the right business insurance

Insurance is your first line of defense. The types you need depend on your industry, but common options include:

• General liability insurance: covers third-party injury, property damage, and advertising claims against your business
• Professional liability insurance (errors and omissions): protects against claims of negligence, mistakes, or failure to deliver services as promised
• Home-based business rider: extends your homeowner's policy to cover business equipment and liability if you work from home
• Commercial auto insurance: required if you use a vehicle for business purposes beyond your standard commute

Separate your finances completely

Open a dedicated business checking account and use it exclusively for business income and expenses. Get a business credit card for purchases. This clear separation makes it harder for creditors to argue your personal and business finances are intertwined, and it simplifies bookkeeping and tax preparation.

Use contracts for every engagement

Written contracts protect both you and your clients. Include clear terms for scope of work, payment, deadlines, and liability limitations. A well-drafted contract can cap your exposure if a project goes wrong and reduce the chance of disputes.

Know when to convert to an LLC

If your revenue is growing, you're taking on higher-risk clients, or your personal assets have increased in value, converting to an LLC may be the right move. An LLC creates a legal barrier between your business obligations and personal property. Read more about the differences between a sole proprietor vs. LLC to help you decide.

Manage your sole proprietorship with Xero

Running a sole proprietorship means you handle everything, including the books. Xero's accounting software simplifies the financial side so you can focus on your actual work.

With Xero, you can:

• Track income and expenses in 1 place
• Send professional invoices and accept online payments
• Connect your bank for automatic transaction imports
• Categorize expenses for easier Schedule C preparation
• Stay organized for tax time with clear financial reports

Whether you're freelancing, consulting, or running a side business, Xero helps you stay on top of your finances without the complexity. Get one month free.

FAQs on sole proprietorships

Here are answers to frequently asked questions about sole proprietorships.

What qualifies you as a sole proprietor?

You qualify as a sole proprietor if you operate an unincorporated business by yourself. No registration is required; you become one automatically when you start selling goods or services for profit without forming an LLC or corporation.

What's the difference between a sole proprietor and self-employed?

Self-employed describes your work status, while sole proprietor describes your business structure. All sole proprietors are self-employed, but not all self-employed people are sole proprietors; some operate as LLCs or corporations.

Can a sole proprietorship have employees?

Yes, sole proprietors can hire employees. You'll need an EIN from the IRS, and you'll be responsible for payroll taxes, withholding, and employment tax filings.

How much does it cost to start a sole proprietorship?

There's no formation cost to start a sole proprietorship. Your only expenses might be a local business license ($25 to $100 in most areas) or a DBA registration ($10 to $50) if you want to operate under a name other than your legal name.

Can a sole proprietorship become an LLC?

Yes. You file LLC formation documents with your state, obtain a new EIN if needed, and update your business bank accounts, contracts, and licenses.

What taxes do sole proprietors pay?

Sole proprietors pay income tax on net business profits plus self-employment tax of 15.3% to cover Social Security and Medicare. You report everything on Schedule C, filed with your personal Form 1040.