A sole proprietorship is an unincorporated business owned by one person, with no legal separation between the owner and the business itself.1Legal Information Institute. Sole Proprietorship You don’t file anything with the state to create one. The moment you start selling products or offering services on your own, without forming an LLC, corporation, or partnership, you’re operating as a sole proprietor by default. It’s the simplest structure available, and the most common: Census Bureau data shows roughly 59% of U.S. businesses have a single owner.2U.S. Census Bureau. Most U.S. Businesses Have Only One Owner The price of that simplicity is unlimited personal liability for every debt and legal claim the business generates.
What You’re Actually Running
Because the business has no independent legal identity, you personally own every asset, sign every contract, and absorb every obligation. There’s no entity standing between you and the people you do business with. If the business owes money, you owe money. If the business gets sued, you get sued.
Most sole proprietors work under their own legal name. You can adopt a trade name, often called a “Doing Business As” or DBA, to put a more professional label on the work. That trade name is an alias for you, not a separate organization. A contract signed under the DBA is binding on you personally.
The Liability Problem
Unlimited personal liability is the defining feature of this structure. Every dollar the business owes is a dollar you owe.1Legal Information Institute. Sole Proprietorship If the business loses a lawsuit or defaults on a loan, creditors can pursue your personal bank accounts, vehicles, investment accounts, and in many cases your home equity.
That exposure isn’t limited to debts you consciously took on. A customer who slips in your workspace, a vendor who claims you broke a contract, a product that causes harm — any of these can produce a judgment that lands on your personal finances. A judgment against the business is a judgment against you.
There’s also no separate business bankruptcy option. If the business becomes insolvent, your personal and business debts are combined and you file as an individual. Service-based businesses often survive this process because a trustee can’t sell your ability to perform work, but the point stands: there’s no corporate wall to hide behind.
How to Start One
No single state filing creates the business, but a few practical steps still need handling before you take on customers.
Register a Trade Name
If you plan to operate under anything other than your legal name, file a DBA registration with your county or state. The filing location varies by jurisdiction. You’ll usually search a local database to confirm the name is available, submit a short form, and pay a fee that generally runs $10 to $100. Some states also require you to publish the DBA in a local newspaper, which adds roughly $50. Processing typically takes a few weeks, and the certificate you receive is what banks will ask for when you open an account.
Get an EIN If It Makes Sense
A sole proprietor with no employees and no excise tax liability can use a Social Security number for every tax filing. An Employer Identification Number isn’t strictly required at that stage. Many sole proprietors get one anyway, because banks often want it for a business account and using an EIN on invoices and W-9 forms avoids handing out your Social Security number. The application is free on the IRS website, takes about five minutes, and the number is issued immediately.3Internal Revenue Service. Instructions for Form SS-4 Once you hire employees, an EIN becomes mandatory.
Pick Up Local Licenses
Most cities and counties require a general business license, even for home-based work. Fees vary widely — anywhere from $50 to several hundred dollars annually, with some cities tying the amount to gross receipts. Depending on your industry, you may also need zoning approval, health department permits, or state-level professional licenses. Your local city clerk or county licensing office is the right starting point.
Open a Separate Bank Account
No law requires a dedicated business account, but skipping this step is one of the most common mistakes new owners make. Mixing personal and business funds creates a tangle at tax time, and claiming personal spending as a business deduction invites IRS scrutiny. The SBA recommends opening a business account as soon as you start taking in or spending money as the business.4U.S. Small Business Administration. Open a Business Bank Account You’ll typically need the DBA certificate, your EIN or Social Security number, and a government-issued ID.
How Taxes Work
Sole proprietorships use pass-through taxation. The business doesn’t file its own return. You report all business income and expenses on Schedule C, which flows into your personal Form 1040.5Internal Revenue Service. About Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship) The net profit becomes part of your adjusted gross income and is taxed at your ordinary income tax rate.
Self-Employment Tax
On top of income tax, you pay self-employment tax to cover Social Security and Medicare. The combined rate is 15.3%: 12.4% for Social Security and 2.9% for Medicare.6Social Security Administration. What Are FICA and SECA Taxes? You’re paying both the employer and employee halves, because no employer exists to split the bill.
Two details soften that. The tax is calculated on 92.35% of your net earnings, not the full amount, and you can deduct half of the self-employment tax you pay when calculating your adjusted gross income, which lowers your income tax bill.7Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes) That deduction is codified in IRC Section 164(f) and applies whether or not you itemize.8Office of the Law Revision Counsel. 26 U.S. Code 164 – Taxes
The 12.4% Social Security portion only applies to net earnings up to $184,500 in 2026.9Social Security Administration. Contribution and Benefit Base Earnings above that threshold are subject only to the 2.9% Medicare tax, plus an additional 0.9% Medicare surtax on self-employment income above $200,000 ($250,000 for joint filers).
Qualified Business Income Deduction
The Section 199A qualified business income deduction was originally set to expire after 2025, but the One Big Beautiful Bill Act, signed into law in July 2025, made it permanent and increased the deduction from 20% to 23% for tax years beginning in 2026.10House Ways and Means Committee. The One Big Beautiful Bill – Section by Section Eligible sole proprietors can deduct up to 23% of their qualified business income before calculating income tax.
The deduction is straightforward for sole proprietors with taxable income below the threshold amount, which is adjusted annually for inflation. Above that threshold, the deduction phases out based on W-2 wages paid and capital investment in the business, and certain service-based businesses (law, accounting, consulting, health care, and similar fields) face additional limits.11Office of the Law Revision Counsel. 26 U.S. Code 199A – Qualified Business Income For most sole proprietors earning moderate income, you simply claim it on your 1040.
Estimated Tax Payments
Because no employer withholds anything from your earnings, you’re generally required to make quarterly estimated tax payments covering both income tax and self-employment tax.12Internal Revenue Service. Estimated Taxes For the 2026 tax year, the due dates are:
- April 15, 2026 for first quarter (January through March income)
- June 15, 2026 for second quarter (April through May income)
- September 15, 2026 for third quarter (June through August income)
- January 15, 2027 for fourth quarter (September through December income)
Missing these deadlines triggers penalties and interest even if you’re owed a refund when you file. You can skip the January 15 payment if you file your full 2026 return and pay the balance by February 1, 2027. Use Form 1040-ES to calculate each payment.13Internal Revenue Service. About Form 1040-ES, Estimated Tax for Individuals
Home Office Deduction
If you use part of your home exclusively and regularly for business, you can claim a home office deduction. The simplified method lets you deduct $5 per square foot of dedicated office space, up to 300 square feet, for a maximum deduction of $1,500.14Internal Revenue Service. Simplified Option for Home Office Deduction The regular method calculates actual expenses (mortgage interest, utilities, insurance, repairs) proportional to the percentage of your home used for business. It’s more work but often produces a larger deduction, and it allows you to claim depreciation on the home office portion.
Keeping Records
The IRS doesn’t mandate a specific bookkeeping system, but you’re responsible for proving every deduction you claim.15Internal Revenue Service. Recordkeeping At minimum, keep receipts for business purchases, bank and credit card statements, mileage logs if you deduct vehicle use, and records of income received. The general rule is to hold onto records for three years from the date you filed the return, with longer windows for substantial underreporting or losses from bad debt.16Internal Revenue Service. How Long Should I Keep Records A simple spreadsheet works; so does accounting software. Consistency matters more than the format.
If You Hire Employees
A sole proprietor can hire employees, and the moment you do, a set of federal obligations switches on. Before a new hire starts work, complete Form I-9 to verify their identity and employment eligibility, and collect a signed Form W-4 to determine how much income tax to withhold.17Internal Revenue Service. Hiring Employees If you don’t yet have an EIN, you need one before processing your first payroll.
Beyond withholding income tax, you’re responsible for the employer portion of Social Security and Medicare taxes (7.65% of wages) and federal unemployment tax. The FUTA rate is 6.0% on the first $7,000 of wages per employee, but credits for state unemployment contributions typically reduce the effective rate to 0.6%.18Internal Revenue Service. Topic No. 759, Form 940 – Employers Annual Federal Unemployment (FUTA) Tax Return You’ll also register with your state for unemployment insurance and carry workers’ compensation insurance.19U.S. Small Business Administration. Get Business Insurance Employment tax records must be kept for at least four years after the tax is due or paid, whichever is later.16Internal Revenue Service. How Long Should I Keep Records
If you sell taxable goods or certain services, most states also require a sales tax permit so you can collect and remit the tax. Rules on what’s taxable and how often you file vary by state, so check with your state’s department of revenue.
Insurance Is Your Main Risk Tool
Because no corporate structure shields your personal assets, insurance is the primary way sole proprietors manage catastrophic risk. The SBA identifies several types of coverage worth evaluating:19U.S. Small Business Administration. Get Business Insurance
- General liability insurance covers claims arising from bodily injury, property damage, and related legal defense costs. It’s the baseline policy for most businesses that interact with the public.
- Professional liability insurance, also called errors and omissions coverage, protects service-based businesses against claims of negligence, bad advice, or missed deadlines. Accountants, consultants, and designers are typical candidates.
- Commercial property insurance covers damage to business equipment, inventory, and physical space from fire, theft, vandalism, and similar events.
- Home-based business insurance is a rider on your homeowner’s policy that covers business equipment and third-party injury liability. Standard homeowner’s policies typically exclude business claims, so this fill is critical if you work from home.
A business owner’s policy bundles general liability and property coverage at a lower combined cost than purchasing each separately. For many sole proprietors, that’s the most cost-effective starting point.
What Happens If You Die or Sell
A sole proprietorship has no existence independent of its owner. When the owner dies, the business legally ceases to exist. All assets and debts fold into the owner’s personal estate and go through probate like any other personal property. A surviving family member can’t simply take over; they’d need to start a new business, acquire the assets from the estate, and apply for their own licenses and permits.
Selling the business during your lifetime works differently from selling a corporation or LLC. There’s no separate entity to transfer, so what you’re actually selling is a collection of individual assets: equipment, inventory, customer lists, intellectual property, and goodwill. The buyer picks which assets they want and the two of you negotiate a purchase price. Leases often need landlord consent to transfer, existing contracts with clients or vendors may need to be renegotiated, and licenses that can’t be reassigned require the buyer to apply from scratch. Some states also require public notice of the sale.
When to Consider Converting to an LLC
An LLC is a separate legal entity filed at the state level. The business can own property, hold bank accounts, and incur debts in its own name. If someone sues the LLC or the business can’t pay a creditor, your personal assets are generally shielded, provided you’ve kept business and personal finances separate and followed state formalities.
Conversion involves filing a certificate of formation (sometimes called articles of organization) with your state, paying the filing fee, and drafting an operating agreement. In most states, the process takes a few weeks and costs between $50 and $500 depending on the state. Some states charge ongoing fees that eat into thin margins.
For federal tax purposes, a single-member LLC is treated as a “disregarded entity,” which means the IRS still treats it like a sole proprietorship. You continue filing Schedule C on your personal return, and you keep your existing Social Security number or EIN for tax filings unless the LLC will have employees, in which case a new EIN is required. The tax treatment stays the same; the liability protection changes significantly.
Conversion makes the most sense when the business starts carrying meaningful risk: you’re signing leases, taking on debt, working with clients who might sue, handling products that could cause injury, or accumulating assets worth protecting. For very low-risk ventures with little exposure to lawsuits or debt, the zero-cost formation of a sole proprietorship can continue to make sense. For anything involving physical products, client-facing services, or meaningful revenue, the liability gap deserves serious thought.