What is a sole proprietor? Taxes, liability, and setup

Published Friday 20 March 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
• How to start a sole proprietorship
• Manage your sole proprietorship with Xero
• FAQs on sole proprietorships

Key takeaways

• Recognize that you automatically become a sole proprietor the moment you start selling goods or services for profit without forming an LLC or corporation, requiring no registration or filing fees to get started.
• Understand that unlimited personal liability is the biggest risk of sole proprietorship, meaning your personal assets like your home, car, and savings can be used to cover business debts or lawsuits.
• Prepare to pay self-employment tax of 15.3% on your net earnings, which covers both the employee and employer portions of Social Security and Medicare taxes that traditional employees split with their employers.
• Apply for an Employer Identification Number (EIN) from the IRS and open a separate business bank account to keep your personal and business finances separate, making bookkeeping and tax filing much easier.

What is a sole proprietor?

A sole proprietor is someone who owns and operates an unincorporated business by themselves. It's a popular structure; in 2019, there were roughly 27.8 million sole proprietors in the US, accounting for 18% of individual taxpayers. With this business type, there's no legal separation between you and your business. You are the business, and the business is you.

If you charge customers for goods or services with the intention of making 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 and graphic designers
• independent consultants
• contractors and handypeople
• personal trainers
• photographers

As your business grows, you can reorganize as an LLC, S corporation, or C corporation.

Learn about other common small business structures:

• What is an LLC
• What is an S corporation

Here are some advantages of operating as a sole proprietor.

Pros of sole proprietorship

The sole proprietorship structure offers several benefits, especially for those just starting out.

It's easy

You become a sole proprietor the moment you start operating—no registration or extra paperwork required.

Lower upfront admin costs

Unlike forming an LLC or corporation, becoming a sole proprietor has no filing fees or formation costs.

Tax is a bit simpler

Tax filing is simpler for sole proprietors than for most other business types. You report business income on Schedule C, which you include with your personal tax return (Form 1040). According to the IRS, you must file if your net earnings were $400 or more.

To file correctly, you'll need to:

• track your income and expenses throughout the year
• understand which expenses qualify as tax deductions
• check if your state requires additional forms

Many sole proprietors work with a tax professional, and while the process is more straightforward than for an LLC or corporation, compliance can be a significant challenge. For example, the IRS attributes approximately $80 billion in unpaid taxes to sole proprietors underreporting income each year.

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 some 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—like your home, car, or savings—can be used to cover those obligations.

Business insurance can help protect against some of this risk.

You'll pay self-employment tax

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

You can deduct the employer half (7.65%) from your taxable income, which reduces your overall tax burden.

You may have to change as you grow

A sole proprietorship can only have one owner. If you want to grow by bringing in partners, selling equity, or raising 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 then explore other structures as their needs change.

Sole proprietorship vs. LLC

Choosing between a sole proprietorship and an LLC comes down to liability protection, taxes, and how much structure you want.

Here are the key differences between the two structures:

• Liability protection: A sole proprietorship offers none; your personal assets are at risk. An LLC creates a legal barrier between your business and personal finances.
• Formation: Sole proprietorships are paperwork-free to start. LLCs require state registration and ongoing compliance.
• Taxes: Both are pass-through entities by default, meaning profits flow to your personal tax return. However, LLCs can elect S corp taxation for potential savings.
• Credibility: Some clients and vendors view LLCs as more established, which may matter in certain industries.

Consider staying a sole proprietor in these situations:

• your business has low liability risk
• you're testing a business idea or running a small side hustle
• you want the simplest, lowest-cost structure

Consider forming an LLC in these situations:

• you have significant personal assets to protect
• your business faces liability risks (client work, physical products, or services)
• you're ready to invest in a more formal structure

You can manage your finances easily with Xero, whether you're a sole proprietor or an LLC.

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. However, a few setup steps can help you run your business smoothly from day one.

1. Check permits and licenses: Verify whether your city, county, or state requires a business permit. Some industries also require professional licenses to operate legally.
2. Apply for an employer identification number (EIN): Get a free EIN from the IRS website. You'll need one to open a business bank account, and it keeps your Social Security number private on business documents. Note that the IRS limits applications to one 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 inexpensive. 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.

Consider business insurance. General liability, professional liability, and other policies can help protect your personal assets from business-related claims. This addresses one of the key risks of operating as a sole proprietor.

Keeping your financial records organized becomes easier with the right tools.

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 one place
• send professional invoices and get paid faster
• connect your bank for automatic transaction imports
• stay organized for tax time with clear 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 and see how Xero makes managing your sole proprietorship easier.

FAQs on sole proprietorships

Here are answers to common 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—you work for yourself rather than an employer. Sole proprietor describes your business structure—an unincorporated business with one owner. All sole proprietors are self-employed, but not all self-employed people are sole proprietors (some operate as LLCs or corporations).

What are some examples of sole proprietors?

Common examples include freelance writers, graphic designers, consultants, photographers, tutors, personal trainers, landscapers, handypeople, and rideshare drivers. Any individual running an unincorporated business on their own is a sole proprietor.

What's the difference between a sole proprietorship and an LLC?

With a sole proprietorship, you and your business are legally the same entity. An LLC creates a separate legal entity, which means your personal assets are typically protected if the business faces lawsuits or debts.

Can a sole proprietorship become an LLC?

Yes, you can convert a sole proprietorship to an LLC. The process involves:

1. Filing LLC formation documents with your state
2. Obtaining a new EIN from the IRS
3. Updating business bank accounts and contracts
4. Checking if you need new licenses or permits

Can I pay myself a salary as a sole proprietor?

Sole proprietors take money from their business through an owner's draw rather than a salary. You won't receive a W-2. Instead, you report all business income on your personal tax return. You can take draws on a regular schedule or whenever you need funds.

What taxes do sole proprietors pay?

Sole proprietors pay two main types of tax on their business income:

• income tax: based on your total taxable income
• self-employment tax: 15.3% for Social Security and Medicare

You report business income on Schedule C, filed with your personal tax return (Form 1040). Since taxes aren't withheld from your earnings, plan to make quarterly estimated payments to the IRS.