A sole proprietorship is a single-owner business that’s never formally incorporated with a state filing. As such, it is not legally separate from its owner. As a result, many individually-owned businesses are sole proprietorships by default. Pros of a sole proprietorship include ease of setup, simplified recordkeeping, and low costs. Cons include the lack of liability protection, limited sources of funding, and an entity life span that ends with the owner.
Sole proprietorships minimize startup costs but won’t limit personal liability. Read on for detailed sole proprietorship pros and cons.
| Pros of a Sole Proprietorship | Cons of a Sole Proprietorship |
|---|---|
| Easy setup and low cost | Unlimited liability |
| No corporate business taxes or double taxation | Must pay self-employment tax on all earnings |
| No annual reports or filings | Difficult to raise capital |
| Not restricted by formal business structure | Inability to take on business debt |
| Easy recordkeeping | Can be seen as unprofessional |
| Decision-making control | Difficulty with succession planning and ownership transfer |
| Save taxes when hiring your children under 18 | Income loss from owner absence |
You can read our guide on what a sole proprietorship is for more information. It also includes how to form one.
7 Pros of a Sole Proprietorship
A sole proprietorship is the easiest type of business to implement. It requires no formal setup, no annual administration, no separate business income tax return, and no formal record keeping beyond tracking revenue and keeping receipts for deductible expenses.
In a sole proprietorship, you simply start selling goods or services—all bills and debts are your responsibility. All business income and expenses are reported on Schedule C of your personal tax return.
Here are seven advantages of a sole proprietorship:
1. Easy Setup & Low Cost
Because a sole proprietorship is not a formal business structure, for tax purposes, there are no filings or paperwork for you to complete before you get started—you simply begin operating. Depending on your industry and operating location, you may need to obtain a surety bond, special license, permit, or business insurance policy.
This ease of setup and low cost of administration/management makes sole proprietorships great for cottage industries and seasonal businesses. If you’re just starting out in a new venture, especially one without substantial liability, then it can be great to use a sole proprietorship until your business is established and growing.
The reason sole proprietorships are easy to set up is that they are not legally a separate entity from their owners. This lack of separation greatly simplifies the setup and reduces the cost but comes at the price of the owner being personally liable for all debts and actions of the business—including actions by employees of the business.
If you’re interested in protecting your liability, it might be best to incorporate as an S corporation (S-corp). It allows for pass-through taxation similar to a sole proprietorship but without all income being subject to self-employment tax.
2. No Corporate Business Taxes or Double Taxation
As a sole proprietor, you don’t pay 21% in corporate taxes on business profits the way you would in a C corporation (C-corp). This is one of the many sole proprietorship advantages.
Instead, you keep filing your personal tax returns and claim any new income from the operation of your business as pass-through income, meaning all income is taxed at your ordinary income tax rate. In addition, sole proprietors are often exempt from state franchise or excise taxes.
These exemptions make taxes far simpler—and cheaper—for sole proprietorships than companies like C-corps, where revenue is first taxed at the company level and then a second time when profits are distributed to shareholders in the form of dividends. The dividend tax rate is currently 15% to 20%, meaning that you can pay as much as 41% on your taxable business profits, which excludes the income tax you pay on your salary.
The typical taxes you may incur as a sole proprietor include:
- Ordinary income tax: As a sole proprietor, you don’t pay yourself a salary. Instead, all profits are reported on your personal tax return and taxed at your ordinary income tax rate. Your tax corresponds to the profit you earn as opposed to the cash you withdraw.
- Self-employment tax: Sole proprietors need to pay self-employment tax on any income from the business, which is both the employer and employee portion of FICA tax. This means you pay the full 15.3% in FICA taxes.
- Payroll tax: If you have employees, you’ll need to collect and pay payroll taxes just like any other business. However, your withdrawals of cash from the business are non-taxable and not reported as wages. For assistance, see our guide on how to fill out Form 941.
- Sales tax: If you sell goods, then you may need to collect and pay sales tax that varies by state but typically ranges from 6% to 9%.
3. No Annual Reports or Filings
Sole proprietorships do not require annual reports or filings with the state to stay current. You don’t have to file anything other than your personal tax returns.
For many sole proprietors, this is an advantage compared with limited liability companies (LLCs), S-corps, and C-corps, which generally are required to file annual reports after they’re formed. These reports typically require updated lists of members or managers to be regularly maintained.
If you decide to operate as a sole proprietorship, you can avoid many filings, including:
- Initial filing: When you formally establish a company
- Annual filing: Required by most states to keep your company current
- Change of manager: If you change managers or directors, you have to notify the state
- List of members: Many types of companies must notify the state when members change
- Annual audit: Some companies are required to submit annual audits
- Entity-level tax returns: Certain types of companies are required to prepare corporate tax returns and pay separate taxes on business profits
The absence of an annual filing is a sole proprietorship advantage because it removes the headache and saves you time—plus, most states charge a fee for these annual filings (ranging from $50 to $200 or more). Additional assessments may also be in place for city and local jurisdictions.
Our guide on how to fill out your Schedule C may be of interest to you. It walks you through each step and covers due dates and additional filing requirements for Schedule C businesses.
4. Not Restricted by Formal Business Structure
Other more formally structured businesses face certain limits on operations in addition to requirements they have to meet. Sole proprietorships are not subject to these requirements.
Some requirements of other types of business that you get to skip as a sole proprietor include:
- Annual meetings: Companies, such as LLCs are required to hold annual meetings to review lists of managers and members
- Board meetings: Some companies are required to have some business decisions formally approved by the directors of the company
- Recorded minutes: Formal minutes need to be kept for these meetings for LLCs and corporations
- Shareholder votes: Any formal actions of the company, including appointing managers or admitting new members, need to be voted on
- Formal reviews: Certain actions of the company need to be formally reviewed, and managers re-appointed
5. Easy Record Keeping
With a sole proprietorship, there is no requirement to keep separate business books and no requirement to have a balance sheet, like other business structures. All you have to do is substantiate the deductions you are claiming.
While this is much simpler, keeping business and personal finances together is typically not recommended, as having separate records helps you monitor cash flow closely. In a sole proprietorship, separating finances won’t protect you from liability—but it can help with bookkeeping as the business grows. It will also make it easier if you decide to transition to an LLC or other formal business structure.
Continue reading:
- How to Open a Sole Proprietorship Bank Account
- Best Business Bank Accounts for Sole Proprietorship
6. Decision-making Control
Choices regarding vendors, sales timelines, customer acceptance, policies, etc. are all under your executive purview. There are no partners with whom to consult, negotiate, or dissent. While there’s no one else with whom you can share culpability, there is also no one else with whom you have to share your plans or profit.
As a result, the business is operated under your sole creative and strategic vision. You can make whatever business decisions you want as long as they’re legal—there’s no formal review or approval process.
7. Save Taxes When Hiring Your Children Under Age 18
Unlike incorporated entities, a sole proprietor can pay wages to their minor children without those wages being subject to FICA or FUTA taxes. The FICA exemption applies to wages paid to the owner’s children under 18 and applies to both the employer and employee FICA obligations. The FUTA exemption extends to children under 21.
Hiring a child offers the sole proprietor an opportunity for an additional wage deduction, which will ultimately reduce taxable income. For more information on this tax saving, read our article on how paying your child from your business can save taxes.
7 Cons of a Sole Proprietorship
It’s important to consider both the advantages and disadvantages of sole proprietorships. The biggest drawback is unlimited liability for a business owner, who can be held personally responsible for the obligations of the business. Also, if you hire employees, you’ll be personally liable for their actions.
The following are the major disadvantages of sole proprietorship.
1. Unlimited Liability
If you’re a sole proprietor, you don’t have any of the limited liability protections offered in a limited liability partnership (LLP), LLC, S-corp, or C-corp. You are personally liable for all business expenses and debts and if someone is hurt on your property or is harmed by a product of your business or a mistake you make. This means that there is no legal difference between you and your business.
Some liabilities in a sole proprietorship that you’ll be personally responsible for are:
- Expenses incurred by your business
- Business-related debts
- Product-related liability
- Property-related injury
- Civil damages if you provide inappropriate or insufficient service
- Actions of employees
Because you have unlimited personal liability in a sole proprietorship, a vendor, customer, or lender can come after your personal assets to satisfy any obligations of the business.
Many sole proprietors convert their entities to LLCs or S-corps once they hire employees to avoid being personally liable for the actions of their employees.
2. Must Pay Self-employment Taxes on All Earnings
Sole proprietors are required to pay self-employment taxes on all earnings. Self-employment taxes are Social Security and Medicare taxes, but unlike employees, self-employed individuals must pay both the employer and employee portion of the taxes. The tax is calculated based on the net earnings from self-employment, which is the amount earned after deducting business expenses from gross income.
The self-employment tax rate is currently 15.3%, which includes 12.4% for Social Security tax and 2.9% for Medicare tax. For 2024, the Social Security tax is only applied to the first $168,600 of your net income, but there is no cap on the Medicare tax. However, if you have earnings over $200,000 a year, then you may need to pay a 0.9% additional Medicare tax.
With an S-corp, the owner only pays FICA tax on their reasonable salary. Any business profit remaining after the salary is subject to income tax, but not FICA or self-employment tax. Learn more about the reasonable salary of S-corp shareholders.
3. Difficult to Raise Capital
Structuring your business as a sole proprietorship is not a good idea if you may need to raise money from outside investors. This is because there’s no real business to sell, so it’s almost impossible to raise money—unless you have tangible assets or intellectual property that investors can buy into.
Sole proprietorships can only have one owner, so they cannot accept equity investments from anyone. If they do accept an equity investment, then they are no longer a sole proprietorship but instead a partnership.
4. Inability to Take on Business Debt
Because a sole proprietorship isn’t a formally established company, it’s impossible to take out a business loan. Instead, all debt—even funds you borrow to grow or operate your business—is personal debt. Lenders will require that any loans be personally guaranteed by a sole proprietor, meaning they can go after your personal assets in case of default.
This is because a sole proprietorship is not a standalone business entity—you are the business. By personally guaranteeing debt for a sole proprietorship, you are committing to lenders that you will repay any loans taken for business purposes, even if the business fails.
This might not be so different from other types of business structures. For example, even if you incorporate as an LLC, there’s a good chance you’ll need to personally guarantee any type of business loan, including an SBA loan. Be sure you understand your personal liability fully when taking on business debt.
5. Can be Seen as Unprofessional
Customers and vendors often view sole proprietors as lacking professionalism. For those who just want to run a small business out of their house or make some extra money in their spare time, this may not be a problem.
When someone sees a sole proprietorship, they know it is owned by a sole person and often have very few, if any, employees. However, if you’re organized as an LLC or corporation, customers and vendors don’t know how large or small your company is by simply looking at your name.
Some of this unprofessionalism can be dismissed by establishing a small business checking account in the name of your business—and you can check out our roundup of the leading small business checking accounts for options. Many providers will allow you to use an alias for your business or a “doing business as” (DBA). However, this will vary by institution.
6. Difficulty with Succession Planning and Ownership Transfer
When a sole proprietor passes away, their sole proprietorship ceases to exist. The assets and liabilities of the business are included in the owner’s estate. While the assets of a sole proprietorship can be transferred to new ownership, the entity itself cannot be.
Adding a new owner to a sole proprietorship would require creating a new entity. With a new entity structure—such as a partnership, corporation, or multi-member LLC—the entity can continue to operate even after the death of the original owner, given the right contingencies.
7. Income Loss From Owner Absence
When a sole proprietor takes a vacation or sick day, business operations may be temporarily suspended if there’s no one around to conduct administrative or day-to-day activities. While a sole proprietor may have employees, many sole proprietorships operate single-handedly because of the liability issues around having employees.
For those individually operated entities, owner absence could halt production for queuing products or services or cause the business to miss out on a prospective sale. Either of these scenarios could result in lost revenue.
For a sole proprietor where this business is their sole source of income, absence could result in an impactful blow to the bottom line. This can be avoided by hiring employees, which might mean forming an LLC or S-corp, as previously discussed.
Our related resources:
- How to Open a Business Bank Account for an LLC
- How to Hire Employees
Alternatives to a Sole Proprietorship
1. Single-member LLC
An LLC is the easiest company to form and administer aside from a sole proprietorship. It can be created in most states online in just 5-10 minutes for $150 to $500. It provides limited liability protection to company owners and is taxed exactly the same as sole proprietors. It even reports its income on Schedule C like a sole proprietorship.
Unlike sole proprietorships, single-member LLCs can elect to be taxed like an S-corp or C-corp. Learn more about the differences between single-member LLCs vs sole proprietorships.
2. S-corp
An S-corp is a closely-held corporation that is generally treated as a pass-through but also receives special tax treatment in certain areas. For instance, while the IRS does not recognize the right of partnerships or sole proprietors to pay themselves a salary, S-corp owners may pay themselves a salary and deduct that expense from corporate profit.
Keep reading: What Is a Reasonable Salary for an S-corp Shareholder?
3. C-corp
Of the various business structures, a C-corp is the most robust and also the costliest. This is largely because C-corps are subject to double taxation, with corporate profits being taxed at 21%. Those profits are then taxed a second time once they are distributed to company owners in the form of dividends, this time at the owner’s individual dividend tax rate.
Our related resource:LLC vs S-corp vs C-corp: What is the Best for Small Business?
Frequently Asked Questions (FAQs)
The biggest advantage of an LLC over a sole proprietorship is that an LLC limits your liability as a business owner. A sole proprietor is responsible for all debts and obligations of their business. In an LLC, business assets are segregated from personal finances, and you are only personally liable for business obligations if you provide a personal guarantee or do something to allow “piercing the corporate veil.”
Organizing as a sole proprietorship is good because it’s very easy to get started and very inexpensive. The unfortunate truth is that a lot of businesses fail, so starting as a sole proprietorship can be a good idea until you see whether your business is going to succeed. This is especially true if you’re starting a business that doesn’t require any outside investment or entails a lot of potential liability.
No, you do not need to register as a sole proprietor with the IRS. You may, however, need to obtain a bond, insurance, or state license, depending on your specific industry and operating location. While not required, it’s a good idea to get an employer identification number to avoid having to disclose your SSN.
Report the income or loss from your business operations on Schedule C of your personal return. Any income or self-employment tax liability is calculated and paid on your individual tax return. You may also need to collect and pay state and local sales tax on any goods sold, depending on where your business is located.
Bottom Line
A sole proprietorship is a great, informal structure that has many benefits for small business owners. When deciding on a type of business structure, it’s important to consider sole proprietorship pros and cons. While these businesses do not offer their owners liability protection and make it difficult to raise money, they’re also incredibly easy to establish and administer.
