What Is a Sole Proprietorship?

Definition and Overview

What is a sole proprietorship? 

As per the Wex Definitions Project, it is a business in which a person owns all assets and assumes the business debts. There is no distinction between the business and the proprietor, who enjoys full control over the sole proprietorship and is entitled to all profits but is subject to unlimited liability for all losses, debts, and liabilities of the business.

Key Characteristics of a Sole Proprietorship

Here are some key characteristics that make sole proprietorship popular among individuals looking for an accessible, flexible way to start and manage a business: 

• You are the owner and controller of the business. You make all decisions and are personally liable for their success or failure.
• A sole proprietorship is easy to start and involves minimal paperwork and costs compared to other forms of business setup. 
• You report income from sole proprietorship business under the personal tax return to avoid the double taxation that other entities, such as corporations, face.
• Profits earned by the business will be transferred directly to you as the owner after you pay taxes.
• Because you are the owner, the business's identity is closely associated with you, which allows for strong personal branding.

Types of Sole Proprietorship

Sole proprietorships vary in type, as business and industry types do. Here are some common types:

Advantages and Disadvantages

Any structure has advantages and challenges, so this also needs to be understood.

One of its most important advantages is the ease of setup with minimal legal procedures and lower startup costs. You have full control over all decisions without consulting the partners; all profits go to you. 

Taxation becomes simpler, too, because business income is reported on your tax return, which avoids double taxation. Its flexibility to change your business and face fewer compliance requirements makes it attractive, too.

On the downside, you have unlimited liability in a sole proprietorship. External funding can be challenging since banks and investors prefer structured business entities. 

There is no built-in business continuity—if you step away or face unforeseen circumstances. 

As income grows, tax burdens may increase without the advantages of corporate tax breaks. Credibility issues arise because some clients may consider sole proprietorships less stable. 

Moreover, handling everything alone can be challenging regarding work-life balance and may limit growth potential.

What is an Example of Sole Proprietorship?

A sole proprietorship can take many forms, and real-life examples of sole proprietorship are all around you:

Comparison: Sole Proprietorship vs. LLC & Entrepreneurship vs. Self-Employment

Here’s a quick comparison between sole proprietorship vs LLC (Limited Liability Company):

In some sense, sole proprietorship has two facets: entrepreneurship and self-employment. 

Here’s a summary of the difference between entrepreneurship and self-employment:

How to Start a Sole Proprietorship 

By following these procedures, you are setting a basis for your sole proprietorship and ensuring the legality and financial soundness of your business: 

1. Define Your Business Idea: Determine the product or service you will sell. Assess market demand and develop a preliminary business plan to direct your activities.

2. Choose a Business Name: Pick a name for your business that is unique, memorable, and easy to spell. Check that it meets state naming laws and is not already claimed.

3. Register a DBA (Doing Business As) Name: If you are doing business under a name other than your legal name, you must file a DBA with your state or local government to make your business name official.

4. Obtain necessary licenses and permits: Check the requirements for any licenses or permits specific to your industry, such as health permits for food businesses, professional licenses for consultants, or sales taxes. 

5. Apply for EIN (Employer Identification Number) or use SSN: Use your SSN (Social Security Number) if you're not hiring employees and filing taxes. Get your EIN (Employer Identification Number) from the IRS if you intend to separate your business accounts, hire employees, or if you wish to gain more credibility for your business.

6. Open a Business Bank Account: Separate your business and personal finances by opening a separate bank account. Tracking business expenses and doing taxes will be easier.

In addition to the above steps, you can keep all business-related expenses, income, and tax documents to facilitate financial reporting and compliance. A pro tip is to set aside funds for quarterly estimated tax payments and keep accurate records.

Common Misconceptions

Here are some common misconceptions about sole proprietorship:

Is a sole proprietorship a business enterprise?  

Many individuals assume that a sole proprietorship is not a true business organization because it does not have a formal legal framework. However, a sole proprietorship is a very valid organization that shares the same business objective as others, such as LLCs and corporations. A sole proprietorship can have contracts, employees, and earnings.

• Small-Scale Business: While sole proprietorships are commonly associated with small-scale small-scale, they are not exclusive to these types. There are many sole proprietorships and established industries.‍
• No Taxes: Others hold that sole proprietorships incur fewer tax requirements than other business types. A sole proprietor is liable for self-employment taxes and must report their business income on their personal income tax returns.‍
• Licenses and Permits Are Not Required: Most believe sole proprietors are exempt from licenses or permits. However, depending on the type of business and location, sole proprietors may be required to obtain specific industry permits, zoning approvals, or business licenses.
• ‍Personal and Business Finances are Always Mixed: Although sole proprietorships are not legally required to separate personal and business assets, good financial practice would advise maintaining separate bank accounts and records for easier tax filing and management.

How Skuad Can Help

A sole proprietorship is preferred because it offers single ownership, sole decision-making authority, a smooth setup, and direct profit retention. However, unlimited liability and scaling issues should be approached carefully. 

But Skuad is here to simplify it. Our Employer of Record (EOR) platform allows you to hire, onboard, and pay employees or independent contractors worldwide by removing the complex compliance regulations that burden payroll management. 

Whether you need a locally or internationally based team to scale, Skuad offers payroll management, tax compliance, and a streamlined contract creation process so you can focus on business growth.

‍Book a demo with Skuad today to learn how we can simplify global workforce management for your sole proprietorship or other business model.

FAQs

What does sole proprietorship mean?

A sole proprietorship is a business owned and operated by an individual. The owner is personally liable for all debts incurred and obligations related to the business. 

What is a sole proprietorship vs LLC?

A sole proprietorship is a simple business owned and operated by only one individual without legally separating the owner from the business, meaning they face personal liability for debts incurred. 

An LLC is a different concept altogether. It is a separate legal identity that provides liability protection to safeguard personal assets and shields from possible business debts. A sole proprietorship is easier to open because it requires less paperwork, whereas an LLC requires more formalities. 

What is one example of a sole proprietorship?

Because of its easy setup, total control, and straightforward tax-filing process, this is a popular type of business setup for freelancers, consultants, and small businesses.

How do sole proprietors pay taxes?

Sole proprietors report their business income and expenses on their tax returns, usually using Form 1040 and Schedule C. The profits from the business are taxed as personal income, meaning they are subject to income tax and self-employment tax, which covers Social Security and Medicare. Since taxes are not deducted from their income, sole proprietors make quarterly estimated tax payments to the IRS. This ensures that they do not fall behind on tax obligations.

How do you change from sole proprietor to LLC with the IRS?

Suppose you change a business from a sole proprietorship to an LLC with the IRS. In that case, you must File Articles of Organization in your state to legally form the LLC, whereby the business name must meet state requirements. Then, obtain a new EIN (employer identification number) from the IRS since your LLC needs to have a separate number. After that, depending on your LLC's choice of taxation or the IRS's rule on single-member LLCs by default, you can file the applicable forms for IRS purposes. Finally, update your business records, including informing clients, banks, and authorities of the change.