Sole Proprietorship

Single Member LLC vs. Sole Proprietorship

LLCs commonly involve multiple members, though, like a sole proprietorship, it’s possible for them to only have a single owner.

Also referred to as a “disregarded entity,” a single-member LLC combines the legal protection of a standard LLC with the pass-through taxation of a sole proprietorship. As a result, the company’s taxes are reported on the owner’s personal tax returns (just like a proprietorship), and the owner’s assets are safe from any company debts (just like an LLC).

Yet, unlike a sole proprietorship, single-member LLCs have the flexibility to function as a corporation instead of a pass-through entity. In such cases, the company files its tax returns via IRS Form 1120 or 1120-S, depending on whether it elected to be a C or S corporation.

How to Start a Sole Proprietorship

Creating a sole proprietorship is one of the easiest ways to start a business:

1. Choose a business name: Pick a name representing the proprietorship’s correct brand and check if it’s available through the state’s business registration office. Note: Some states require registering a business name before it may be used.
2. Obtain licenses and permits: Depending on the industry, a sole proprietor may need local, state, or federal licensing. Most states, however, do not have formal sole proprietorship registration.
3. Open a separate bank account: Separating business and personal finances makes tracking proprietorship income and expenses much easier while maintaining clear, organized records.
4. Register for taxes: While proprietors can use their Social Security number (SSN) as a sole proprietorship tax ID, applying for an Employer Identification Number (EIN) can make tax management easier. Moreover, a sole proprietorship EIN is essential if the business hires employees.

Sole Proprietorship Taxes

Sole proprietorship taxation is simpler than other business structures, as all income and expenses are reported on the owner’s personal tax return using Schedule C (Form 1040).

While there’s no separate sole proprietorship tax form, owners may need to make quarterly estimated tax payments and pay self-employment taxes (Social Security and Medicare).

What are the Benefits of a Sole Proprietorship?

While sole proprietorship offers a simple, cost-effective way to start and manage a business, it also has unique risks and drawbacks.

Sole Proprietorship Advantages

The advantages of sole proprietorship make it one of the most common choices for small business owners.

• Ease of setup: Establishing a sole proprietorship business requires minimal steps. Often, it’s just choosing a business name, securing any required licenses and permits, and (in some cases) registering with the state. Unlike corporations or LLCs, there are no complex formation documents or annual reporting requirements.
• Low cost: With little to no upfront filing fees, sole proprietorships are an inexpensive and quick way to begin operations.
• Full control: The sole proprietor has complete decision-making authority over every aspect of the business, from daily operations to long-term planning or budgeting. This level of control allows for quick pivots and flexibility that multi-owner entities may lack.
• Simplified taxes: Instead of filing separate corporate tax returns, business income and expenses flow directly onto the owner’s personal tax returns using Form 1040 Schedule C.
• Direct access to profits: All earnings belong solely to the owner, with no obligations to share them with partners or shareholders.
• Easy to dissolve or convert: If the business needs to close or transition to another business structure (like an LLC or C corporation), doing so is straightforward and inexpensive.

Sole Proprietorship Disadvantages

Despite its appeal, a sole proprietorship carries several risks and limitations.

• Unlimited personal liability: Because there’s no legal distinction between the owner and the business, the owner’s personal assets (e.g., home, car, savings, etc.) can be seized to settle business debts or legal judgments.
• Difficulty raising capital: Proprietorships often struggle to access funding because they cannot sell equity or shares. Instead, they typically rely on personal savings, small business loans, or lines of credit, which can limit growth potential.
• Limited credibility: Some vendors, lenders, and clients may perceive sole proprietorships as less established compared to incorporated entities, making it harder to secure contracts or build partnerships.
• Lack of continuity: A sole proprietorship is tied directly to the owner’s life status, meaning it typically dissolves if the sole proprietor retires, becomes incapacitated, or passes away. This can complicate long-term and succession planning.
• Potentially higher taxes: A sole proprietorship doesn’t face double taxation like corporations do (paying taxes on profits and then on money paid out to shareholders). However, it may have higher self-employment taxes and fewer deductions, which can lead to higher overall taxes despite easier filing.