What Is a Sole Proprietorship?

Definition & Examples of a Sole Proprietorship

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sole proprietorship is an unincorporated business owned by one individual, making it the simplest form of business to start and operate.

Learn more about sole proprietorships and if it's appropriate for you.

What Is a Sole Proprietorship?

A sole proprietor is an unincorporated business owned exclusively by one person. Millions of sole proprietorships are operating in the United States, making it one of the most popular forms of business ownership. Someone is also considered a sole proprietorship for tax purposes if they are the single member of a domestic LLC.

How Sole Proprietorships Work

The sole proprietorship's key feature is that unlike an incorporated business or a partnership, there is no legal separation between the business and the owner. The business is considered an extension of the owner, so the owner is personally responsible for any debts or liabilities incurred by the business.

Benefits of a Sole Proprietorship

A sole proprietorship is the easiest and least expensive form of business to set up and operate. If you operate your business under your own name with no additions, you don't even need to register your business name to start operating as a sole proprietor. This makes the sole proprietorship ideal for business startups, self-employed contractors, and part-time and home-based businesses. Other benefits of a sole proprietorship include:

  • Full ownership
  • Simpler taxes and accounting
  • Deductible business losses

As a sole proprietor, you own 100% of the business and get to make all the decisions. Unlike corporations, sole proprietors are not required to hold shareholder's meetings or take votes on management issues. You can also manage your own schedule and hours of operation, depending on the customers' requirements.

Sole proprietorships are much simpler to operate from a tax and accounting perspective because you do not need to file a separate business tax return—all income generated from the business is reported on your personal tax form. The business owner receives all profits directly. As with other forms of business, your expenses related to the cost of doing business are deductible from income tax. This includes:

  • Travel expenses
  • Automobile expenses
  • Advertising
  • A portion of your home expenses if you are operating a home-based business

Business losses can be deducted against other forms of income, so a sole proprietorship that loses money in the early years can deduct the losses against personal income, making it ideal for those wishing to transition from employee to self-employed over some time.

Disadvantages of a Sole Proprietorship

Being self-employed in a sole proprietorship often means having no employees or partners to discuss business issues, explore new ideas, or interact with on a social basis. Other significant downsides include:

  • No legal separation
  • Exposure to liability
  • Business income reported as personal income
  • Difficulty getting contracts
  • Hard to sell the company

With a sole proprietorship, there is no legal separation between you and the business, so if the business fails and incurs debts, your personal assets—including your home and any other assets registered in your name—could be seized to discharge the liabilities (which can be unlimited). Likewise, if you are sued for damages caused by accident or negligence in your business activities, your personal assets can also be seized.

If your business activities could expose you to substantial liability, a sole proprietorship is probably not suitable for business.

While tax simplicity can be an advantage for sole proprietorships, it can also be a disadvantage in terms of flexibility because all business income must be reported as regular income in the year it was earned. Incorporated companies have much more flexibility in terms of how and when the owners are paid.

Some businesses and government agencies will not deal with unincorporated businesses because they view a sole proprietorship as not having the same level of legitimacy and professionalism as an incorporated business. Many also believe a sole proprietor increases the risk of the tax authorities treating the person as an employee rather than an independent contractor.

Sole proprietorships can also be difficult to sell because the business is completely tied to the owner. Since there is no distinction between the assets of the owner and the business's assets, the proper valuation of the business can be hard to achieve. Operation wise, unless the sole proprietor has friends or family members who can carry on running the business, illness, or injury can affect business continuity. Customer loyalty resides with the original owner of the business and may not readily transfer to a new owner.

Key Takeaways

  • A sole proprietorship is an unincorporated business owned by one individual.
  • The gains and losses of the sole proprietorship are reported on the owner's personal income tax return.
  • The owner of a sole proprietorship is responsible for all debts and liabilities.

Article Sources

  1. IRS. "Sole Proprietorships." Accessed August 9, 2020.

  2. IRS. "Publication 334 (2019), Tax Guide for Small Business." Accessed August 9, 2020.

  3. IRS. "Self-Employed Individuals Tax Center." Accessed August 9, 2020.

  4. IRS. "About Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)." Accessed August 9, 2020.

  5. IRS. "Deducting Business Expenses." Accessed August 9, 2020.