All About Sole Proprietors and Sole Proprietorship

The Sole Proprietor Business, From Startup to Taxes and More

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 is the most common form of business organization in the U.S. and includes over 23 million people. This type of business represents 73 percent of all businesses in the U.S. today.

A sole proprietor business is the easiest business type to start and operate. You don't need to formally register your business with your state, unlike corporations or LLCs. Some disadvantages exist with a sole proprietor business, as well.

One question that's often asked is the difference between a sole proprietor and an independent contractor. A small business can be both a sole proprietor for the purpose of paying income taxes and an independent contractor for the purpose of getting paid by companies for work. 

If you are a sole proprietor or you have considered starting a sole proprietorship, find out more about this business form.

What Makes a Sole Proprietor So Unique?

What makes the sole proprietor so unique and favorable as a business type? 

  • It's easy to form, with no requirement to register with a state.
  • It's easiest to run, with no regulations about having a board of directors, meeting minutes, or annual meetings. 
  • The owner is in complete control of the business, not having to answer to anyone. 
  • The owner gets all of the profits of the business, but of course he or she must also take all of the losses. 

Advantages and Disadvantages of the Sole Proprietorship

The benefits of starting your business as a sole proprietorship may or may not outweigh the disadvantages, depending upon your own situation. 

The biggest disadvantage of the sole proprietorship is that your personal legal and financial situation and the business financial and legal situation are one and the same.

This means that a business bankruptcy would affect your personal finances. It also means that any lawsuits against the business can affect you as an individual, or your family. 

Another disadvantage of this business type is that you must pay income taxes and self-employment tax (Social Security and Medicare tax) on the entire income of the business. If your business is profitable, that can be a big bill to pay. 

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 will need to take care of some other legal matters. You'll need to

  • get a business license with your locality 
  • apply to the state for sales tax permits
  • get any specific licenses and permits, depending on the type of business you are starting. For example, a food business will need a health permit. 

How a Sole Proprietorship Pays Income Tax

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 then all of the business expenses you want to deduct. You can include home business expenses if you operate your business from your home, and car expenses if you drive for business purposes. 

The total net income from Schedule C is then entered on Line 12 of your Form 1040, along with income from other sources. 

You'll calculate self-employment tax based on the net income of your business and add this after the income tax is calculated. The income tax and self-employment tax are totaled to arrive at your total tax liability.

Taxes Paid by a Sole Proprietorship

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 sold.
  • Pay property tax on any real property (land and buildings) you own.
  • If your sole proprietorship has employees, you must collect, report, and pay employment taxes

Sole Proprietor or Independent Contractor?

The terms "sole proprietor" and "independent contractor" may be confusing. A small business can be both a sole proprietor and an independent contractor.

The sole proprietor designation is a high-level description used for federal income tax purposes. It means that a sole proprietor pays income taxes on revenue shown on Schedule C, on their individual tax return, as detailed above. For example, a sole proprietor may produce and sell a product to customers and pay taxes on the sales proceeds.

An independent contractor works for someone else and receives a 1099-MISC form (similar to a W-2 form for employees) showing income for the year. They will show their income from the 1099 form as self-employment income on Schedule C.