A sole proprietorship is an unincorporated business owned by one person, with no legal distinction between the owner and the business. You don’t file paperwork to create one. The moment you start selling goods or services for profit without registering an LLC or corporation, you are already operating as a sole proprietor.1U.S. Small Business Administration. Choose a Business Structure That simplicity is the appeal. The lack of legal separation is the cost.
How It Starts
There is no application, charter, or state filing that brings a sole proprietorship into existence. The structure is the default for any individual doing business on their own account.
The one filing you may need is a “Doing Business As” registration, sometimes called a fictitious or assumed name filing. States require it when you operate under a trade name instead of your own legal name, so the public can identify who stands behind the business. Fees and procedures vary, and the filing is usually handled at the county or state level.
Personal Liability
Because you and the business are the same legal entity, every debt the business owes is your debt. Every lawsuit against the business is a lawsuit against you. If a customer wins a judgment, or you default on a business loan, creditors can reach your personal bank accounts, your home, and other assets you own. There is no corporate shield.
Insurance is the main stopgap. A general liability policy covers bodily injury and property damage claims. Professional liability coverage, often called errors and omissions insurance, protects against claims that your work was negligent or incomplete. Neither closes the structural gap, but together they absorb most of the exposure that actually turns into a claim.
When an LLC Makes More Sense
A single-member LLC is taxed the same way as a sole proprietorship by default. The IRS treats it as a “disregarded entity,” and you still file Schedule C. The difference is legal, not tax: the LLC is a separate entity, and in most situations only the assets inside the LLC are at risk if the business is sued or can’t pay its debts.1U.S. Small Business Administration. Choose a Business Structure
The tradeoff is cost and paperwork. LLCs require state formation filings, and most states charge annual report fees or franchise taxes to keep the entity in good standing. A written operating agreement is standard even for a single member, and a federal beneficial ownership report may be required. For a freelancer with modest income, those costs may not pencil out. For someone signing client contracts or carrying real liability exposure, the protection usually does. An LLC also opens tax options a sole proprietorship doesn’t have, including an election to be taxed as an S corporation or C corporation if the math later favors it.
Federal Income Tax
A sole proprietorship does not file its own tax return. Business income and expenses flow through to your personal return on IRS Schedule C, which produces your net profit or loss.2Internal Revenue Service. Sole Proprietorships That net figure moves onto your Form 1040 and is taxed at your regular individual rates.3Internal Revenue Service. About Schedule C (Form 1040)
Pass-through treatment means no separate corporate tax. It also means every dollar of profit is taxable to you whether or not you withdraw it. There is no option to leave earnings inside a separate entity and defer the tax the way a C corporation can.
Self-Employment Tax
On top of income tax, sole proprietors owe self-employment tax, which funds Social Security and Medicare. The combined rate is 15.3 percent: 12.4 percent for Social Security and 2.9 percent for Medicare.4Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes) A W-2 employee only sees half that rate taken from their paycheck because the employer pays the other half. You cover both sides.
The threshold is low. You owe self-employment tax once your net earnings reach $400 for the year.5Internal Revenue Service. Instructions for Schedule SE (Form 1040) The calculation is done on Schedule SE and the result is added to Form 1040.
One offset: you can deduct the employer-equivalent half of your self-employment tax when calculating adjusted gross income. The deduction appears on Schedule 1, is available whether or not you itemize, and reduces your income tax though not the self-employment tax itself.4Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes)
Estimated Quarterly Payments
No one is withholding tax from your earnings, so you are generally required to pay estimated taxes four times a year. The IRS expects quarterly payments if you anticipate owing $1,000 or more for the year after withholding and refundable credits.6Internal Revenue Service. Form 1040-ES – Estimated Tax for Individuals
The quarterly calendar is uneven:
- April 15, covering January through March
- June 15, covering April and May
- September 15, covering June through August
- January 15 of the following year, covering September through December
Payments are submitted using Form 1040-ES or through the IRS online payment system. Underpaying or skipping installments results in a penalty computed as interest on the shortfall, even if you pay everything you owe when you file your annual return.7Internal Revenue Service. Frequently Asked Questions for Estimated Tax
Deductions That Matter
Ordinary business expenses like supplies, software, and advertising reduce your net profit directly. A few larger deductions deserve attention on their own.
Qualified Business Income Deduction
The Section 199A deduction lets sole proprietors deduct up to 20 percent of their qualified business income before federal income tax is calculated.8Office of the Law Revision Counsel. 26 U.S. Code 199A – Qualified Business Income Congress extended it past its original 2025 expiration, so it remains available for 2026. Below roughly $201,750 for single filers and $403,500 for joint filers in 2026, the full 20 percent generally applies without limitation. Above those thresholds, the deduction phases down for certain service-based businesses such as law, accounting, and consulting.
Home Office
If you use a dedicated space in your home exclusively and regularly for business, you can deduct a portion of your housing costs. The simplified method gives you $5 per square foot of office space, up to 300 square feet, for a maximum deduction of $1,500. The regular method requires calculating the percentage of your home used for business and applying it to mortgage interest or rent, utilities, insurance, and depreciation.9Internal Revenue Service. Publication 587 (2025), Business Use of Your Home The “exclusively” requirement is strict. A kitchen table you also use for family dinners does not qualify.
Self-Employed Health Insurance
Sole proprietors who pay for their own health coverage can deduct premiums for medical, dental, and vision insurance for themselves, their spouse, and their dependents. It is an above-the-line deduction reported on Schedule 1, so it reduces adjusted gross income directly. You cannot claim it for any month you were eligible to participate in a health plan subsidized by an employer, including a spouse’s employer plan.10Internal Revenue Service. Instructions for Form 7206
Retirement Plans
Working for yourself doesn’t cut you off from tax-advantaged retirement saving. The main options differ in contribution limits and administrative complexity.
Solo 401(k)
A solo 401(k), also called a one-participant 401(k), lets you contribute as both the employee and the employer. For 2026, you can defer up to $24,500 as the employee. On top of that, you can make an employer profit-sharing contribution of up to 20 percent of your net self-employment income after deducting one-half of self-employment tax. The combined total cannot exceed $72,000 for 2026.11Internal Revenue Service. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs Age-based catch-up contributions add $8,000 for most savers 50 and older.12Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
SEP IRA
A Simplified Employee Pension IRA carries less administrative overhead than a solo 401(k). Contributions are limited to the lesser of 25 percent of compensation or $72,000 for 2026.13Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs) For a self-employed individual, the effective rate works out to roughly 20 percent of net income, because the deductible portion of self-employment tax has to come out first. A SEP IRA opens at any brokerage and has no annual filing requirements until assets reach a certain level.
SIMPLE IRA
A SIMPLE IRA allows salary reduction contributions of up to $17,000 in 2026.14Internal Revenue Service. Retirement Topics – SIMPLE IRA Contribution Limits The ceiling is lower than a solo 401(k) or SEP IRA, which makes it most useful for sole proprietors with modest income who want a straightforward plan.
Setting up any of these plans, apart from a SEP IRA used without employees, generally requires an Employer Identification Number from the IRS.15Internal Revenue Service. Publication 1635 – Understanding Your EIN
Hiring Family
Employing your children in a sole proprietorship carries payroll tax breaks you won’t find in any other business structure. Wages paid to your child under age 18 are exempt from Social Security and Medicare taxes. Wages paid to your child under 21 are exempt from federal unemployment tax.16Internal Revenue Service. Family Employees If the child earns less than the standard deduction, which is $16,100 in 2026, they owe no federal income tax on those wages.17Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 You deduct the wages as a business expense, which reduces both your income tax and your self-employment tax.
The work has to be real. Age-appropriate tasks, reasonable pay for the job, and proper time records. The IRS will scrutinize arrangements that look like income shifting dressed up as employment.
Hiring a spouse works differently. Wages paid to a spouse are subject to income tax withholding and Social Security and Medicare taxes, just like any other employee. The one break is that those wages are not subject to federal unemployment tax.18Internal Revenue Service. Married Couples in Business
EIN, Licenses, and Records
For tax purposes, most sole proprietors use their personal Social Security number. You need a separate Employer Identification Number if you hire employees, set up a retirement plan, or withhold taxes on payments to non-resident aliens.19Internal Revenue Service. Employer Identification Number An EIN is free and takes minutes to obtain through the IRS website. Many sole proprietors get one anyway, simply to avoid handing clients their Social Security number on W-9 forms.
Beyond the EIN, license and permit requirements depend on your industry and location. A freelance writer working from home may need nothing more than a municipal business license. A food vendor likely needs health permits, a sales tax registration, and possibly a specialized state license. Check with your city and county clerk’s office.
The IRS requires records that support every item of income, deduction, or credit on your return. For most sole proprietors, that means holding onto receipts, bank statements, and mileage logs for at least three years after the return is filed. If you underreport income by more than 25 percent, the retention period extends to six years. Records tied to property, including equipment, vehicles, and real estate, should be kept until at least three years after you dispose of the asset, because they’re needed to calculate depreciation and any gain or loss on the sale.20Internal Revenue Service. How Long Should I Keep Records?
Selling or Closing
Because a sole proprietorship has no separate legal existence, you can’t sell the business as a single asset. You are selling individual assets: equipment, inventory, customer lists, goodwill. Each category gets its own tax treatment.21Internal Revenue Service. Sale of a Business Inventory sales produce ordinary income. Equipment and real property held longer than a year follow special rules that can produce either capital gain or ordinary income depending on depreciation recapture. Goodwill and other intangibles typically generate capital gains. Buyer and seller must both file Form 8594, which allocates the purchase price across asset categories, whenever goodwill could attach.22Internal Revenue Service. Instructions for Form 8594 – Asset Acquisition Statement Under Section 1060
If you are simply closing rather than selling, the process is less formal. Cancel any licenses and DBAs, file your final Schedule C, and if you have an EIN, notify the IRS that the business has closed. A sole proprietorship ends when the owner stops operating it. There is no dissolution filing.