A sole proprietorship is an unincorporated business owned and run by one individual. The owner is entitled to all profits but is also responsible for all debts and liabilities.
Steps to Establish Your Business
To start a sole proprietorship, obtain any licenses and permits required by your state or local government. There are minimal legal requirements.
As a sole proprietor, you can deduct regular business expenses on your personal taxes. You have two options to pay yourself: a salary like an employee with withheld taxes, or drawing money from business profits as needed.
Tax Implications and Personal Liability
A sole proprietor reports income and expenses on a Schedule C form on their personal tax return, paying income and self-employment taxes. An employer identification number (EIN) is not required; you can use your Social Security number as your taxpayer ID.
Sole proprietors may convert to an LLC or corporation if they desire, though some maintain their sole proprietorship status, particularly if it serves as a side hustle or for small-scale freelance businesses.
Managing Risks and Future Growth
As a sole proprietorship grows or takes on debt, the owner risks personal assets to cover business losses and liabilities. You retain complete control over decision-making but have unlimited personal financial liability. Transitioning to an LLC or corporation is an option to limit personal liability.
When considering bringing a spouse into the business, it’s important to understand the changes in tax and liability implications.
Self-employment is a broader term that includes sole proprietors, independent contractors, and partners. While a sole proprietorship is easy to establish due to little regulation, it carries significant personal financial risk and tax obligations for the single owner. It is important to weigh these factors carefully when structuring your small business.