You may be running a sole proprietorship and not even know it.
Sole props are the most basic business structure in the US. They’re also the default entity. With a few exceptions, as soon as you go into business for yourself, you’re operating as a sole prop.
But is it the right business structure for you? And how can you be sure you’re running it correctly?
Consider this your sole prop crash course. We’ll cover everything you need to know: How a sole prop works, which types of businesses usually operate as sole props, pros and cons, and how the taxes work.
What is a sole proprietorship?
When you run a sole proprietorship, you and your business are identical for tax purposes (even if you have a registered business name).
All your business income and expenses are filed with Schedule C, along with your personal tax return on Form 1040. Since you’re a business, if you expect to pay $1,000 or more in taxes, you’ll need to file estimated taxes.
When you run a sole proprietorship, you’re liable for everything the business is liable for. If your business owes someone money, you owe them that money personally. And if someone sues your business, they’re suing you personally.
Sole proprietorships vs. LLCs
A limited liability company (LLC) operates similarly to a sole proprietorship. If you are the only owner, you have complete control of the company. But, unlike a sole proprietorship, you can also share ownership of the LLC with another person.
The LLC structure protects you from personal liability. In terms of taxes, it’s a separate entity. It has its own debts, can be sued, and can file for bankruptcy.
An LLC takes more work than a sole proprietorship to set up. And there are also fees involved—about $1,000 worth, on average. If you’re interested in this business structure, learn more about how to transition from a sole proprietorship to an LLC.
Sole proprietorships vs. partnerships
If you’re planning to go into business with a partner, consider making your company a partnership. Think of a partnership as a sole proprietorship that’s owned by multiple people.
To form a partnership, every member needs to sign a partnership agreement. Drawn up with help from a lawyer, this document determines what share each partner has in the business.
That’s important when it comes to liability. Like a sole prop, a partnership is identical, tax-wise, with the people who run it. Every member reports business income and expenses on their personal tax returns. And, unlike the LLC, a partnership doesn’t shield you from liability (unless it’s a limited liability partnership).
How to form a sole proprietorship
As soon as your venture starts turning a profit, you’re a sole proprietorship. This applies to both the 16 year old mowing his neighbor’s lawn for gas money, and the wealthy tech entrepreneur investing her personal fortune to colonize the Moon. Until you file the necessary paperwork to structure your business otherwise, you’re a sole prop.
That being said, there are a few requirements you need to meet before going into business.
Turn a profit
The IRS won’t consider you a sole proprietorship if they consider what you’re doing to be a hobby.
Let’s say you’re passionate about the chakra-balancing potential of chihuahua yoga, so you teach classes by donation. In total, you barely make enough to cover the cost of mat spray and milkbones.
In this example, you’re practicing a hobby. Unless you can prove you’re set up in order to turn a profit, the IRS won’t consider you a business.
Start charging $30 a class and showing a healthy profit margin, and it’s time to start reporting your income to the IRS—who now consider you a sole prop by default.
Get all the right licenses and permits
State by state, there are different laws for what types of licenses or permits a business may need to operate. This also depends which industry you’re in: bookkeepers don’t need a pesticide applicator license, but exterminators do. Check out the Small Business Association’s Business License and Permits to find out what licenses and permits you need.
Typical sole prop businesses
There are certain types of businesses that usually run using the sole prop business structure.
Typically, they don’t require a substantial initial investment to get started—for instance, in the form of equipment or a brick-and-mortar location. That means they don’t need the same loan liability protection, or the ability to bring on investors, as other types of businesses.
- Landscaping businesses often start off as a single individual doing landscaping work, who may bring on employees or contractors to meet seasonal demand.
- Home healthcare workers frequently operate as contractors, serving multiple clients in their homes. The sole prop is a good fit for this business model.
- House cleaning businesses may start out as side hustles for their owners. Sole proprietorship is a good, simple structure for them.
- Catering companies may get started informally—for instance, one talented cook feeding their friend’s wedding guests—before taking off.
- Freelancers, from developers to copywriters, typically operate as sole proprietorships. Since they’re contractors who invoice clients, the organization of their business is fairly straightforward.
- Consultants and speakers may operate as a sole prop as side businesses for someone who is otherwise employed full-time. One example is a full-time business executive who occasionally helps other companies improve their operations.
The pros and cons of running a sole proprietorship
Like anything, running a sole prop has its upsides and its downsides.
Pros of running a sole prop
When you have a sole prop, you’re the sole owner. While you’re liable for all the business’s debts, you’re also entitled to all its income. And when it’s time to make a business decision, you’re not legally required to check with shareholders or partners.
Cheap and easy setup
It costs zero dollars to operate a sole prop under your own name. All you need to do is make sure you file your taxes correctly. Contrast this with other business structures. Virtually every other one costs money to form.
No red tape
Corporations and partnerships have to follow a lot of regulations, especially in terms of how the business is structured, who gets the power to make certain types of decisions, and what information needs to be disclosed to which members. Sole proprietorships are free of these requirements.
Simple tax filing
The only extra tax form every sole prop is required to fill out is Form 1040 Schedule C. That’s it—there are no complicated new routines you need to learn just because you’re a sole prop.
Of all business structures, sole props have the smallest requirement for recordkeeping. Day-to-day bookkeeping is important—it lets you plan your business’s future and correctly file your taxes on time. But it’s simple compared to other business structures. For instance, corporations have to keep three different sets of books—one for internal use, one for the board, and one for the IRS.
Cons of running a sole prop
If your business owes someone money, so do you. And if someone sues your business, they’re suing you personally. Other structures—LLCs and corporations—act as a shield for this kind of liability. The sole prop doesn’t provide any kind of shield.
If a sole prop owner decides to go out of business, the company dissolves. That makes it hard to maintain continuity long-term. For instance, if you own a convenience store and you want to pass the business on to one of your kids, you’ll have to jump through some hoops. Other structures make this easier—by letting you bring them on as a co-owner or business partner before you leave.
Difficulty raising loans
In general, banks are less likely to loan money to a sole proprietorship than to a different business structure. They’re seen as less “professional” and stable. Also, since you can’t sell shares of your sole prop—as you can with a corporation—it may be difficult to bring on investors.
Even if you’re a seasoned business maven, there’s something to be said for bringing more than one point of view to the table. When you have a corporate board overseeing your company—or partners or co-owners to consult with—you can rally more experience and expertise to make business decisions.
Are you outgrowing your sole prop? Does all this talk of personal liability give you the heebie jeebies? Learn more about how to transition from a sole prop to an LLC.