What is sole proprietorship? Definition, FAQs, and resources

Sole proprietorship offers simplicity for solo business owners. Learn the benefits, setup, and tax implications.

Table of contents

Key takeaways

• Recognize that sole proprietorships offer the simplest business setup with no formal registration required, but expose you to unlimited personal liability for all business debts and legal issues.

• Implement proper financial separation by opening a dedicated business bank account and obtaining an EIN, even if not legally required, to maintain clear records and establish business credibility.

• Prepare for self-employment tax obligations by setting aside funds for the 15.3% Social Security and Medicare taxes on net earnings, and make quarterly estimated payments if you expect to owe $1,000 or more.

• Consider transitioning to an LLC or corporation structure when your business grows, as sole proprietorships limit your ability to raise capital from investors and may reduce credibility with customers and vendors.

How to set up a sole proprietorship

Setting up a sole proprietorship is the simplest way to start a business. Unlike other business structures, you don't need to file paperwork with the state or pay registration fees.

To set up a sole proprietorship, follow these steps:

Time to set up: Most sole proprietorships can be operational within days or weeks, depending on licensing requirements.

Advantages of sole proprietorship

offer several key benefits that make them attractive to new business owners and freelancers.

Set up and operational advantages:

Financial benefits:

Disadvantages of sole proprietorship

Sole proprietorships come with significant risks that you should consider before choosing this business structure.

Liability and financial risks:

Operational challenges:

Tax requirements for sole proprietors

Sole proprietors report business income and expenses on their personal tax returns, making tax filing simpler than other business structures.

Key tax obligations:

Record keeping requirements:

Sole proprietorship vs LLC and other business structures

Choosing the right business structure depends on your liability concerns, tax situation, and growth plans.

Feature

Sole Proprietorship

LLC

Corporation

Set up complexity

Very simple

Moderate

Complex

Personal liability

Full liability

Limited liability

Limited liability

Tax filing

Personal return

Flexible options

Separate return

Ongoing costs

Minimal

State fees

Higher fees

Credibility

Lower

Higher

Highest

When to consider other structures:

Manage your sole proprietorship finances with confidence

When you run your own business, you manage everything, including your finances. Staying organized from the start helps you track your financial health and manage cash flow. It also makes tax time less stressful. With clear insights into your income and expenses, you can make smarter decisions and focus on growing your business.

Xero makes bookkeeping simple with tools designed for small businesses. You can track expenses, send invoices, and see your real-time financial position. Try Xero for free.

Frequently asked questions about sole proprietorships

Do sole proprietors need an EIN?

You only need an Employer Identification Number (EIN) if you plan to hire employees or must file certain excise tax returns. Many banks also require an EIN to open a business bank account, so it can be helpful to get one even if it’s not required.

What are the pros and cons of a sole proprietorship?

The main advantages are that it’s easy and inexpensive to set up, you have full control, and taxes are simple. The main thing to watch out for is that you are personally responsible for business debts or legal issues.

Can a sole proprietorship have employees?

Yes, a sole proprietorship can hire employees. If you do, you’ll need to get an EIN from the IRS and handle payroll taxes.