What is a sole proprietorship?

Citizens Staff

What is a sole proprietorship? It's a simple business structure in which the owner and business are one entity, profits and losses are reported on a personal tax return, and a company launches when the owner starts conducting business. Sole proprietorships are popular with freelancers, consultants and small retailers.

Sole proprietorships require minimal time and money to establish, but they do have some limitations. A sole proprietorship is an unincorporated business in which there can be only one owner. Without the creation of a separate legal entity, such as a corporation, the owner and the sole proprietorship are the same. This means that in the case of a lawsuit or debt, creditors may pursue a sole proprietor's personal assets such as a house, car, cash or investments.

Read on to learn how to form a sole proprietorship and its unique benefits and challenges. Check with your attorney, tax expert or financial advisor when making decisions about your business structure.

How sole proprietorships are formed

Compared to other business structures, such as limited liability corporations (LLCs), corporations and partnerships, establishing a sole proprietorship is easy. In most states, if the owner operates under his or her own name, a sole proprietorship does not need to be registered, and a business is launched when someone starts operating. 

However, many sole proprietors choose to take additional steps for professionalism, marketing and operations, including:

• Creating an alternative business name. Establishing a "doing business as" (DBA) name may help create a distinct company identity for marketing and branding purposes. Also, some banks require a DBA to open a business account.
• Obtaining licenses or permits. Obtaining federal, state or local licenses may be necessary for certain types of businesses.
• Procuring an EIN. Businesses with employees may need to register for an Employer Identification Number (EIN).
• Setting up a business banking account. A dedicated business banking account can contribute to business credibility, keep your business and personal finances separate, and streamline financial management.

Advantages of sole proprietorship

To fully answer the question "What is a sole proprietorship?" it is important to understand its advantages and disadvantages.

Sole proprietorship advantages

• Quick and easy to form. Unlike many business structures, establishing a sole proprietorship does not typically require a lot of time, effort and expense.
• No additional taxes to file. Business income and losses in a sole proprietorship flow through to an owner's personal tax return, meaning that running one does not typically require an owner to file extra business tax returns. Check with your tax advisor about tax requirements.
• Operational simplicity. With only one owner, a sole proprietor does not have to build consensus for decision-making with partners or other owners.
• Easy to shut down. Dissolution of a sole proprietorship may only require filing a Form 4797 (if any assets need to be sold) and the canceling of permits, licenses or DBA.

Disadvantages of sole proprietorship

All business structures have downsides. For a sole proprietorship, many stem from the fact that a sole proprietorship isn't a separate legal entity from its owner.

• No liability protection. Unlike an LLC, corporation or some partnerships, sole proprietorship does not provide liability protection from lawsuits or debts. This puts the owner's personal assets such as a car or house at risk.
• Limited ownership. A sole proprietorship may only have one owner.
• Funding. A sole proprietor cannot raise capital by selling equity, because it is not legally a separate entity from the business.
• Succession limitations. A sole proprietorship must be run by its owner and cannot be inherited. Upon the owner's passing, the assets become part of the owner's estate, but the business itself ceases to exist.

Is a sole proprietorship the right choice?

With the pros and cons in mind, ask yourself the following questions to determine if a sole proprietorship may be the right business structure. Always check with your attorney, accountant and financial advisor before making any decisions.

• How clear is my business vision? For entrepreneurs starting a business to provide services they are accustomed to selling — think freelancers or consultants who have been working in a large company — a sole proprietorship may provide a quick way to hit the ground running in a business with few surprises. An owner testing a business concept might also choose this business structure while a product or service is in flux to determine what type of entity might work best in the long run.
• What is my growth likely to be? Businesses planning on rapid growth and the need for investors may be better off establishing a business structure other than a sole proprietorship to accommodate multiple owners and investors. Some partnerships, LLCs and corporations provide more options for ownership and investment.
• What is my liability level? Sole proprietorships are typically best suited for businesses such as freelancers, consultants or small retailers with limited liability. This is because the owner is personally liable for all debts and lawsuits associated with a business.
• What tax structure is best? Part of the appeal of sole proprietorships is that profits and losses pass through to an owner's personal tax return. However, other structures may offer better tax planning opportunities and incentives, so speak with your tax advisor to make a decision.
• Do I mind running things alone? As a one-owner-only structure, sole proprietorships place the burden for decision-making, financing and company operations on one person. While this can have the advantage of not having to build consensus to make company decisions, it can be a lot to manage alone.

Sole proprietorship FAQ

• What does it cost to form a sole proprietorship? In most instances, startup costs are limited because sole proprietors don't have to register with the state. However, any startup may have associated expenses, including obtaining a DBA if you choose, marketing and sales, and product or service delivery.
• Can sole proprietorships have employees? Yes, sole proprietorships may have employees. Apply for a free Employer Identification Number (EIN) if you plan to hire.
• How can I keep my personal and business finances separate? It's wise to keep personal and business expenses separate for bookkeeping, taxes and tracking company profitability, among other reasons. A fundamental way of doing this is to establish a business banking account. Also consider applying for a business credit card to track work-related expenses, earn rewards, and build a business credit history.
• Should I consult with an attorney, accountant or financial advisor? Speaking with a legal, tax or financial expert is not a requirement, but is prudent if you have unanswered questions about the liability of your business, tax obligations or your financial status.
• Can a sole proprietorship be converted to an LLC or corporation? A business owner can change business structures from a sole proprietorship to another type of entity, but it would not be a conversion as much as the creation of a new business structure since a sole proprietorship is not a separate entity from the owner.

A sole proprietorship is a quick, easy-to-form business structure with limited liability and fewer tax burdens than some types of businesses. As you weigh its benefits and limitations to choose the best business structure, be sure to create a strong financial foundation by establishing a business checking account. A business checking account can contribute to business credibility, keep your business and personal finances separate, and streamline financial management. Look for an account that offers mobile banking, overdraft protection, and invoicing and accounting tools.

Ready to take the First Step?

When forming any type of business, a business checking account is an essential first step to deposit, move and borrow money for your business. With a Citizens business checking account, you'll have all of the features you need to manage your business’s finances.

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