What You Need To Know About Starting a Sole Proprietorship

Image shows a man in a bakery wearing a green apron that has a nametag that reads "bob". He is holding a tray of muffins, and standing in front of the pastry case and the register which says "Bob's Bakery." Text reads: "Sole proprietor business in the U.S.–Pro: the owner is in complete control and gets all of the profits. Con: The owner's personal finances and business finances are one and the same. 73% of all business in the U.S. are sole proprietor businesses"

Image by Mary McLain © The Balance 2019

A sole proprietorship, or a single-owner business, is the most common form of business organization in the U.S, representing nearly 87% of all businesses without employees in the U.S. A sole proprietor business is the easiest business type to start and operate.

This article describes a sole proprietorship business and discusses the major facts you need to know for starting this type of business.

Key Takeaways

  • A sole proprietorship is a one-person business that isn’t registered with a state.
  • A sole proprietorship is easy to start; all that’s needed is a business name and address, a business bank account, and state and local licenses and permits.
  • The sole proprietor business is a federal tax entity, reporting its taxes as part of the owner’s personal income tax return.
  • A sole proprietor is self-employed and must pay self-employment tax for Social Security and Medicare benefits.
  • A sole proprietorship can deduct all typical business expenses, including home office and business driving costs.

What Is a Sole Proprietorship?

A sole proprietorship is a one-person business. It’s the simplest form of business to operate because you don’t need to register it with a state or have a board of directors or complex legal documents. Some examples of sole proprietors are freelancers, independent contractors, and gig workers, such as Uber and Lyft drivers.

A sole proprietorship is also a tax entity, and the IRS considers your business income as part of your personal tax return.

While owning a sole proprietorship sounds simple, there are drawbacks. The biggest issue with owning a sole proprietorship is that there’s no legal separation between the personal affairs of the owner and the business. The owner is personally responsible for the debts and legal obligations of the business.

Income and Expenses for Sole Proprietorships

As a sole proprietor, you’ll want to keep track of your sources of income for tax purposes. Your payments can come:

  • Directly from individuals
  • From other businesses, which will send you a 1099-NEC form for non-employee compensation
  • From sales of products or services

You will have different types of expenses, depending on your business type. Some expenses every business has include: 

  • Advertising and marketing
  • Fees for advisors such as accountants and attorneys
  • A place to operate from, such as a home office, retail space, or professional office
  • Supplies and office expenses
  • Taxes, licenses, and permits for your business type
  • Insurance, including general business liability and professional liability insurance

If you are selling products, you can deduct the cost of those products, called cost of goods sold. There is a special calculation on your business tax form for this cost.

Steps in Starting a Sole Proprietorship

A sole proprietorship is the easiest form of business to start. All a sole proprietor business owner needs for a startup is:

You don't need to register your business with your state, but you may need to take care of some other legal matters.

Business License

Depending on your business type, you may need to get a business license with your locality. If you run a freelance writing business from your home, you may need a general business license, or no license at all. But if you’re an attorney, you’ll need to get a license to practice from your state. And a food business will need a health permit.

If your business name is different from your personal name, you will need a fictitious name permit (sometimes called “Doing Business As” or “DBA”) from your locality. For example, if your name is Pat Patterson and your business name is something like “Cars R Us” that doesn’t include your name, you will need a fictitious name statement saying you’re doing business as Cars R Us.

Sales Tax Permits

Apply to your state for sales tax permits if you are selling taxable goods or services.

You may also need a sales tax permit if you are selling online. Check with your state’s taxing authority for more information.

Paying Income Taxes on Your Business Income

A sole proprietorship pays income taxes by completing a Schedule C and including this income on the owner's personal tax return. Schedule C lists all the income of your business and all of the business expenses you want to deduct, with sections for home business and business driving expenses. The total net income from Schedule C then is entered on your Form 1040, along with income from other sources.

Each business deduction comes with qualifications and limitations. Get help from a licensed tax professional or use business tax software to guide you through this process.

Self-Employment Tax

Everyone who works in the U.S. must pay Social Security and Medicare taxes. A sole proprietor pays this tax as self-employment tax based on the net income of their business.

First, you prepare Schedule C to get the net income from your sole proprietorship. You then calculate self-employment tax on this amount. You will add these amounts to your income tax and most likely pay them in your estimated quarterly taxes.

Start Paying Other Taxes

Sole proprietorship businesses must pay taxes in the same manner as other businesses. All of these taxes must be reported and paid at specific times and amounts. In addition to income tax, your business must:

  • Collect and pay sales taxes on taxable goods and services your business sells
  • Pay property tax on any real property (land and buildings) you own, such as an office or warehouse
  • Collect, report, and pay employment taxes if your sole proprietorship has employees

Frequently Asked Questions (FAQs)

Does a sole proprietor have to register with the IRS?

Most businesses must get an Employer Identification Number (EIN) from the IRS for federal taxes. A sole proprietorship doesn’t need this number if it doesn’t have employees, it doesn’t pay certain types of taxes, and doesn’t have a Keogh (retirement) plan. If you don’t get an EIN, you will use your Social Security number when you prepare Schedule C for your sole proprietorship business.

How much does a sole proprietor have to make to file taxes?

Because your income as a sole proprietor is part of your personal tax return, the rules around whether you should file a tax return for a particular year depend on how much you earn. You must file a tax return if your income is at least a specific amount, based on your filing status. For example, a single person younger than age 65 must file a return if their gross income is at least $12,550. A married couple younger than age 65 filing jointly must file if their combined gross income is more than $25,100.

What expenses can you write off as a sole proprietor?

You can write off all your business expenses as a sole proprietor in the same way as other business types can. To deduct these expenses, they must be ordinary (common and accepted for your business type, such as tools for a carpenter) and necessary (helpful and appropriate for your trade or business, such as a business car for a cleaning service business). See the Instructions for Schedule C for a list of deductible expenses along with qualifications and limitations.

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