What is a Sole Proprietorship?

what is a sole proprietorship, hands holding a sole proprietorship notebook

Estimated reading time: 4 minutes

The entrepreneurship journey starts with an idea for a product or service, starting a new business, or buying an existing company. Launching a startup or taking over full ownership of an already established business is challenging and time-consuming, but the benefits are worth the risk. There will be many tasks to complete, such as creating a business strategy, developing a marketing plan, handling legal and compliance responsibilities, and keeping track of finances.

One of the most important decisions you will make is picking a business structure for your company. There are several options to consider, including a sole proprietorship. This Balboa Capital blog article answers a common question many aspiring business owners ask: what is a sole proprietorship?

Sole proprietorship definition.

A sole proprietorship, as the name implies, is an unincorporated business owned and operated by one individual. The business owner is responsible for every aspect of the company’s operations and bookkeeping. One of the most significant benefits of this type of business structure is that there are no formalities to set up or maintain. It also has the least amount of paperwork and legal requirements. As a result, most business owners and lawyers regard it as the simplest business structure.

Entrepreneurs in many industries opt to operate as sole proprietors, including general business owners, franchise business owners, and independent contractors/freelance workers.

How to start a sole proprietorship.

If, after researching the various types of business legal structures, you decide that a sole proprietorship is the best choice for your needs and brand, it is time to get started. As a sole proprietor, your company’s legal name needs to be your personal name. If you want to use a fictitious or trade name, you must file a “doing business as” name, also referred to as a DBA. It is a good idea to check to see if the fictitious name is not already registered.

The name you select is a personal decision, but it is recommended that you use one that represents your brand and is suitable for business. After you pick a name, whether personal or fictitious, contact your local county clerk’s office to find out the next steps. They will provide you with information and guidance regarding business licenses, permits, and zoning permits.

Next, you will need to apply for an employee identification number (EIN) for your sole proprietorship if you hire one or more employees or file an excise or pension plan. In these instances, you will need to use your EIN rather than your social security number (SSN).

Overview of income taxes.

A sole proprietorship affords the owner the benefit of simplified tax returns. A sole proprietorship is not considered a separate legal entity from its owner. As a result, taxes are not separated from the business; all business income and losses are included on the owner’s tax return. The IRS forms needed for filing income tax returns are the Schedule C form and the personal IRS 1040 tax return.

Sole proprietors are required by law to make quarterly tax payments to the IRS. The reason is that sole proprietors are not employees, so income and self-employment taxes are not withheld from their salaries. The quarterly tax payments are based on how much the owner estimates for the year at the April 15 federal tax deadline.

Owners must also pay self-employment taxes such as Medicare and Social Security. However, no self-employment tax is paid if a sole proprietor reports a loss. That said, the owner will not get Medicare or Social Security benefits for that particular year.

Potential tax deductions.

In many instances, sole proprietorships are eligible for tax deductions so long as they are deemed “ordinary and necessary” for business operations, as per the IRS. For example, some standard deductions include business equipment such as computers, software, printers, and phones, and utilities and rent. In addition, sole proprietors can deduct the cost of their healthcare insurance. Again, a certified accountant is an excellent resource should you have questions or need more information about business tax deductions.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.