Sole Proprietorship: What It Is, How to Start, and When to Move On

What Is a Sole Proprietorship?

A sole proprietorship is the simplest business structure. If you start doing business without forming an LLC, corporation, or partnership, you are a sole proprietorship by default. There is no paperwork to file with your state to create one. You and the business are legally the same entity.

This is how most small businesses begin. The handyman who starts picking up jobs on weekends. The consultant who lands a few clients. The contractor who decides to go independent. You start working, you start earning, and congratulations — you are a sole proprietor.

How to Start a Sole Proprietorship

Starting is straightforward because there is no formal formation process. Here is what you actually need to do:

1. Choose a Business Name

You can operate under your legal name or choose a "doing business as" (DBA) name. If you choose a DBA, you will need to register it with your county or state. More on that in our DBA guide.

2. Get an EIN (Optional but Recommended)

Technically, sole proprietors can use their Social Security Number for tax purposes. But getting an Employer Identification Number (EIN) from the IRS is free and takes five minutes online. It keeps your SSN off invoices and business documents, and you will need one if you ever hire employees.

3. Open a Business Bank Account

This is not legally required, but it is practically essential. Mixing personal and business finances is a headache at tax time and looks unprofessional to clients. Most banks require an EIN or DBA filing to open a business account.

4. Get Required Licenses and Permits

Depending on your industry and location, you may need a general business license, professional license, or specific trade permits. Check with your city, county, and state.

5. Understand Your Tax Obligations

As a sole proprietor, you report business income on Schedule C of your personal tax return (Form 1040). You are also responsible for self-employment tax (15.3%) covering Social Security and Medicare. You will likely need to make quarterly estimated tax payments to avoid penalties.

Advantages of a Sole Proprietorship

Simplicity. No formation documents to file. No annual reports. No corporate minutes. You just work.

Low cost. You avoid the filing fees, registered agent fees, and annual state fees that come with LLCs and corporations.

Complete control. Every decision is yours. No partners to consult, no board to report to.

Simple taxes. Business income flows directly to your personal return. One set of books, one tax return.

Easy to dissolve. If you decide to stop, you just stop. No dissolution paperwork with the state.

The Big Risk: Unlimited Personal Liability

Here is where sole proprietorships get dangerous. You and your business are the same legal entity. That means if your business gets sued, your personal assets — your house, your car, your savings — are all on the table.

If a subcontractor you hired damages a client's property, you are personally liable. If a client slips and falls on a job site, you are personally liable. If you cannot pay a business debt, creditors can come after your personal assets.

Insurance helps mitigate this, and every sole proprietor should carry adequate general liability and professional liability coverage. But insurance has limits, exclusions, and deductibles. It is not a perfect shield.

When to Move Beyond a Sole Proprietorship

You should seriously consider forming an LLC or corporation when:

• Your revenue grows. Once you are consistently profitable, the liability protection of an LLC is worth the modest cost.
• You take on larger contracts. Bigger jobs mean bigger potential liability.
• You hire employees or subcontractors. More people involved means more risk.
• You want tax flexibility. An LLC taxed as an S-Corp can save you money on self-employment taxes once your income is high enough.
• A client requires it. Some general contractors and commercial clients require their subs to be registered business entities.

The sole proprietorship is a great starting point, but it is meant to be temporary for most growing businesses. Once your revenue justifies the cost and your risk profile demands protection, it is time to level up.

Self-Employment Tax: The Hidden Cost

Many new sole proprietors are shocked by self-employment tax. As an employee, your employer pays half of your Social Security and Medicare taxes. As a sole proprietor, you pay both halves — a combined 15.3% on net self-employment income up to the Social Security wage base (this threshold adjusts annually — check IRS.gov for the current year's limit), plus 2.9% Medicare tax on everything above that.

You can deduct the employer-equivalent half of self-employment tax on your Form 1040, which helps. But the total tax burden is still significantly higher than what you paid as a W-2 employee. Plan for it.

Record-Keeping Essentials

Even though sole proprietorships are simple, the IRS still expects you to keep adequate records. At minimum, track:

• All income received
• All business expenses with receipts
• Mileage logs for business driving
• Home office measurements if you claim that deduction
• Asset purchase records for depreciation

Good record-keeping is not just about surviving an audit. It is about knowing whether your business is actually making money, and finding every deduction you are entitled to.

Bottom Line

A sole proprietorship is the fastest, cheapest way to start a business. It is perfect for testing an idea or doing work on the side. But it offers zero liability protection and limited tax flexibility. For most contractors and small business owners who are serious about growth, it is a stepping stone to an LLC or S-Corp — not a permanent destination.