Sole Proprietorship Basics

The sole proprietorship is the simplest legal structure for owning your own business.

Updated by Peri Pakroo, J.D. · University of New Mexico School of Law

A "sole proprietorship" is a one-person business that's not registered with the state as a corporation or a limited liability company (LLC).

Sole proprietorships are so easy to set up and maintain that you might already have one without knowing it. For instance, you're automatically a sole proprietor if you're:

  • a freelance photographer or writer
  • a craftsperson who takes jobs on a contract basis
  • a salesperson who receives only commissions, or
  • an independent contractor who isn't on an employer's regular payroll

A growing number of people are becoming sole proprietors, with many running their businesses out of their homes. As soon as you start selling a good or service, you become a sole proprietor.

However, even though a sole proprietorship is the simplest of business structures, you shouldn't fall asleep at the wheel. You might have to comply with various legal requirements such as local registration, business license, or permit laws to make your business legitimate. And you're personally responsible for paying both income taxes and business debts.

Personal Liability for Business Debts

A sole proprietor can be held personally liable for any business obligation. So, if your business doesn't pay a supplier, defaults on a debt, or loses a lawsuit, the creditor can legally come after your house or other possessions.

By contrast, the law provides owners of corporations and limited liability companies (LLCs) with what's called "limited personal liability" for business obligations. This means that, unlike sole proprietors and general partners, owners of corporations and LLCs can normally keep their house, investments, and other personal property even if their business fails.

If you'll be engaged in a risky business, you might want to consider forming a corporation or an LLC.

Paying Taxes on Business Income

In the eyes of the law, a sole proprietorship isn't legally separate from the person who owns it. Instead, it's considered a pass-through entity for tax purposes. The fact that a sole proprietorship and its owner are one and the same means that a sole proprietor simply reports all business income or losses on that person's individual income tax return, IRS Form 1040, with Schedule C attached.

As a sole proprietor, you'll have to take responsibility for withholding and paying all income taxes, something an employer would normally do for you. So, you'll have to pay a "self-employment" tax, which consists of contributions to Social Security and Medicare, and pay estimated taxes throughout the year.

Depending on your income, you might qualify for a a 20% tax deduction. For example, if you have $50,000 in pass-through income and qualify for the 20% deduction, only $40,000 (or 80% of your total income) would be taxed.

You might have to get an employer identification number (EIN) from the IRS if you have employees. Otherwise, you'll use your Social Security number for taxes.

Registering Your Sole Proprietorship

Unlike an LLC or a corporation, you generally don't have to file any special forms or pay any fees to start working as a sole proprietor. All you have to do is state that your business is a sole proprietorship when you complete the general registration requirements that apply to all new businesses.

In practice, lots of businesses are small enough to get away with ignoring these registration requirements. But if you're caught, you might be subject to back taxes and other penalties.

Registering Your Fictitious Business Name (FBN)

If you do business under a name different from your own, you usually must register that name— known as a fictitious, or assumed, business name. For example, suppose Daisy Johnson provides computer coding services as a freelancer under the name "Quake Coding." Because her company name doesn't include her full legal name, Daisy will need to register her business name.

You'll usually need to register your name with the county where your business is located. But some states require registration with the state instead of the county, while others require you to register your name in every county you'll do business in. Check with your county clerk and secretary of state's office for specific requirements.

Obtaining a Tax Registration Certificate

Most cities (or counties, if you live in a rural area) require all businesses to register with the local tax collector, regardless of business type, structure, size, or name. Depending on your city or county, there might be different names for the process, including:

  • tax registration
  • business tax application
  • business license application, or
  • tax certification.

In a nutshell, getting a tax certificate is your local government's way of charging your business a fee or other taxes. The office that handles local tax registration is sometimes called a tax registration office, tax collector, or city treasurer. Contact your local office for details on handling this registration.

Obtaining a Seller's Permit

In most states, any business—whether it's a sole proprietorship, partnership, LLC, corporation, or any other type—must have a seller's permit if it sells any tangible goods to the public. Tangible goods are things you can touch, such as furniture, clothing, or food. Businesses that sell only services, such as a color consultant or tax preparer, are often (but not always) exempt from the seller's permit requirement.

A seller's permit allows your business to collect sales taxes from customers to cover any sales tax that you'll owe to the state. Sales tax is generally calculated as a percentage of your taxable sales. You'll typically pay any taxes you owe at year-end, semiannually, quarterly, or monthly.

To obtain a seller's permit, contact the agency in your state that governs sales taxes, which could be the same agency that deals with income taxes. The process of obtaining a seller's permit typically consists of submitting a simple application form and, sometimes, paying a fee.

Securing Specialized Licenses and Environmental Permits

Various licenses and permits are required of certain businesses for certain activities, sometimes for certain locations. Figuring out what permits or licenses you might need can be confusing as there are literally hundreds of independent agencies from the local to the federal level that regulate various businesses.

So here's a quick overview of who typically regulates what.

Local Regulations and Zoning Laws for Businesses

Local laws regulate which activities are allowed in particular locations. Assuming your business has met zoning requirements, it still might need to be approved by other city agencies, such as:

  • the fire department
  • the police department
  • the building inspector, or
  • the department of public health.

You'll typically learn about what requirements apply to your business when you complete the local tax registration process.

State Regulations for Businesses

State regulations often focus on how you conduct your business and public safety. For instance, your state wants to make sure that your cosmetologists are competent, your bartenders know when to cut someone off, and your carpenters do safe work.

Your state might require the business owner and certain employees (the ones performing the activity) to take a class, pass a test, and pay a fee to obtain a license. The business itself might need a license specific to its activities.

Check your state websites (including the tax agency and secretary of state) to see if they offer small business assistance or a "one-stop-shop" for licensing information.

Federal Regulations for Businesses

The federal government doesn't regulate small businesses as heavily as local and state offices. But you might need a federal permit or license to engage in certain activities such as:

  • manufacturing drugs or meat products (Food and Drug Administration)
  • alcohol or tobacco products (Bureau of Alcohol, Tobacco, and Firearms), or
  • providing investment advice or counseling (Securities and Exchange Commission).

Speak With a Lawyer

It can be tricky to decide whether to register as an LLC or corporation or to stay a sole proprietor. It can be even more difficult to navigate the myriad of federal, state, and local laws, and to know when they apply to your specific situation.

If you're unsure about which kind of business to form or what rules to follow, you should talk to a small business attorney. They can explain the advantages and disadvantages of each business structure as it relates to your specific case, and provide guidance on which registrations, licenses, and permits you should obtain. They can also help you report and pay your taxes to the IRS and your state government.

Find the business structure that fits your business. Take our business formation quiz for help deciding the best structure for your business.
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