What Is a Sole Proprietorship?

A sole proprietorship is an unincorporated business that is owned by one individual with no legal distinction between the business and owner. In this form of business, the owner and the business are taken as one and the same person.

It is also sometimes referred to as a “sole trader”, “individual entrepreneurship”, or “proprietorship.”

A sole proprietorship is the easiest form of business to set up and there are no registration formalities involved in forming one. 

However, just like all businesses, a sole proprietor still needs to secure licenses and permits prior to business operation.

It is popular for many businesses such as consulting, freelancing, and so on because it is an easy form of business to maintain when the number of employees remains low. 

Considering how less complex of a business form it is, a sole proprietorship is often the first choice for many to begin their business ventures.

Forming a Sole Proprietorship

A sole proprietorship can be formed by merely conducting business under the owner’s given name or company name. The steps to forming one are as follows:

1) The first step would be for the business owner to register his/her personal details with their state tax office. The owner should also secure all other necessary licenses and permits.

2) When the owner decides on the business name, he/she should register the same with the state.

3) When an employee is required for running the business, it would be necessary to file employment tax returns and withhold taxes from any wages/salaries paid.

Note that registration regulations may vary according to state, industry, and locality.

Advantages of a Sole Proprietorship

The advantages of this form of business are as follows:

It is a simple form of business and requires less time, money, and energy.

It is usually easy to set up since there are no registration formalities involved. This form of business may be ideal for those who want to set up a small enterprise on their own quickly.

The tax forms and registration forms required are minimal in comparison to other forms of business.

Although registration policies vary according to factors like state or type of industry, the establishment of a sole proprietorship is generally less complicated compared to other business structures.

There may be some savings when it comes to legal fees when the proper steps are taken when forming a sole proprietorship.

Because this business structure isn’t as complex as others, the owner may be able to save money that would have been used in putting up the business had it been a partnership, LLC, or corporation.

Disadvantages of a Sole Proprietorship

The disadvantages of a sole proprietorship are as follows:

It does not provide any liability protection for the owner, therefore all personal and business risks are taken by the owner alone.

Because there is no distinct separation between the owner and the entity, all personal and business risks shall be assumed by the sole owner.

The owner is personally liable for all business debts and legal action taken against the business.

In the event of bankruptcy or any other unforeseen circumstances, creditors that may be owed by the business can sue the owner for payback even if it is not their personal property.

Income tax liability falls upon the sole proprietor and not on any legal entity like an LLC or corporation.

The entire income earned from the business shall be taxed by the Internal Revenue Service (IRS) as the sole proprietor’s personal income.

Limitations on raising capital for the business.

Because the sole owner is in control of all business finances, raising capital for his/her business may be limited to personal finance or credit.

Final Thoughts

A sole proprietorship is a popular form of business due to its simplicity and low cost. However, it is important for one to keep in mind that this type of business provides little protection against liabilities

It is often advisable to consider other forms of business when the number of employees grows much higher.

Also, with the possible tax liabilities involved, the owner must have sufficient knowledge of taxation policies with regard to earnings from a sole proprietorship.

Since a sole proprietorship is essentially an individual or a business with no distinction from its owner, any income earned from this entity shall be taxed as the owner's personal income.
Yes, it may hire employees to help them run the business. However, it is important to know that employment tax returns and withholding taxes from any wages/salaries paid will be needed as well as registering the employees with the state.
A sole proprietorship does not provide liability protection for the owner like most other forms of business do. Instead, all risks and liabilities are shouldered by the owner alone. The tax preparation required is minimal in comparison with other forms of business; however, there is little in the way of retirement or salary plans in a sole proprietorship.
When creating a sole proprietorship, there are only two things that must be done. These are securing necessary business licenses/permits and registering the business name with the state.
Losses resulting from a sole proprietorship are compensated for by the owner. This means that the business' individual losses shall be taken care of by its single owner.
True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.