A sole proprietorship is an unincorporated business owned by one person who pays personal income taxes on profits. In simpler terms: a sole proprietorship is not a separate entity from its owner. For better or worse, you are the business and the business is you.
lt’s the simplest business structure there is, and it’s straightforward and cheap to start. You’ll have less paperwork to file to start up a sole proprietorship. You’re considered a sole proprietor once you start selling your goods or services, as long as you haven’t registered as any other type of business entity and don’t have any partners.
Sole proprietorships are often attractive to entrepreneurs for the full control they give the business owner. No partnerships to navigate, no boards to please. Plus, tax filing is made simpler because you include your business in your personal tax filing. And many sole proprietors may find they’re eligible for a qualified business income tax deduction.
But of course, a sole proprietorship also comes with drawbacks. The most serious one is the personal liability risk you take on as a sole proprietor. We discuss that more below.
Sole proprietorships: Good news and bad news
The good
✅ Minimal cost and paperwork to get started.
✅ Full control over business; no need for board meetings or other corporate formalities.
✅ Simple tax filing and potential for Qualified Business Income tax benefit.
The bad
❌ Harder to get funding through investors or bank loans.
❌ Complete personal liability for the business and its debts.
❌ Responsible for paying self-employment tax; potentially at higher risk of being audited.
» Dive deeper into the advantages and disadvantages of sole proprietorship.
Your liability risk as a sole proprietor
There is no separation, legally or financially, between you and your business when you operate as a sole proprietorship. This means that any legal or financial hot water your business gets in also puts your personal money and belongings at risk.
Say, for example, your business holds personal data of your clients that is meant to remain secure. But you experience a data breach and your clients’ data is exposed online. One or more of your clients then decides to sue you. Your own personal money and assets such as your home and car are on the line if you lose the lawsuit.
If you’re a sole proprietorship with employees, then you have the added risk and responsibility not only of your own actions but those of your staff. Say you own a catering business and one of your employees is driving the catering van to an event. On the way to the gig, your employee rear ends another car at a stop sign. You, as the employer, are personally liable for the damage caused and costs to repair it.
The issue of personal liability is typically the most important factor for any business owner to weigh when determining whether a sole proprietorship is the right choice. (If you’re eager to answer that question now, you can jump to the section of this page that will help you answer it.)
How to start a sole proprietorship
A sole proprietorship may be right for you if you find that the independence, simplicity and low costs outweigh the risks. Here are some initial steps.
- Consult a lawyer or accountant. A professional can help you fully understand the pros and cons of a sole proprietorship for your particular business.
- File for a “doing business as” name, or DBA. Having a name for your business other than your personal name can lend more credibility to your business. You’ll need to search records to make sure your desired name isn’t being used by someone else, and you should also make sure you don’t infringe on another company’s trademark.
- Apply for an employer identification number (EIN). You can apply for free with the IRS. Some clients may require a tax ID number, or EIN, on invoices. It’s also necessary to have one if you plan to hire employees.
- Get a business license. Contact your city or county clerk for more information on requirements, and the office of your secretary of state for other licensing rules.
- Open a business bank account. While this step is not legally required to operate as a sole proprietorship, it is most highly recommended. Having a separate bank account for all of your business costs makes bookkeeping and tax filing simpler and more accurate. It also puts you in better standing in the event of an IRS audit.
- Purchase business insurance. You’ll definitely want general liability insurance to cover you in the event of any physical injury or damage to property as a result of your business operation. And if you’re in the business of providing any sort of financial or professional advice, it would be wise to purchase professional liability insurance.
Your sole proprietorship questions answered
Is my personal property on the hook if someone sues my business?
Yes, absolutely. As a sole proprietor, you and your business are one and the same. If someone sues your business and you are found liable, then your personal finances and property are on the line.
Can I use my personal bank account for my business?
You can, but we don’t advise it. The IRS also advises against this. Mixing your personal and business finances makes extra work for you and increases the risk of error when it comes to filing your taxes. Entangling your business and personal finances also makes for a messier situation if you happen to be audited by the IRS.
Can a sole proprietorship hire employees?
Yes, you can. You will definitely need an employer identification number if you plan to have employees. Also be aware that having employees as a sole proprietor increases your personal liability risk as you are also personally responsible for the actions and errors of your employees.
What if I want to bring on a partner?
You cannot remain a sole proprietor if you choose to bring in a co-owner. If you choose to bring on a partner and don’t form another business entity, such as an LLC or LLP, your sole proprietorship automatically becomes a general partnership (there’s still some necessary paperwork involved in the change).
Is a sole proprietorship right for you?
When answering this question, you’ll want to consider both the level of risk within your business industry and your personal assets that may be on the hook.
How much risk does your industry carry?
You can use this table to get a quick sense for how risky your particular business is if you’re going to carry full personal liability as a sole proprietor.
| Risk level | 🟢 Low | 🟡 Medium | 🔴 High |
| Industry | Work-from-home or low-overhead services | In-person services | Services related to physical safety or professional advice |
| Examples | Graphic design, photography, tutoring, freelance writing | Landscaping, personal training, event planning, catering | Daycare/nanny, construction, financial advising, dog walking and pet care |
What do you stand to lose?
- If you own real estate: Your home or property is at risk in the event of unpaid debts. Business lenders often place a lien on your business in the event you fail to pay off your loan. If your business is not separate from you, as is the case with a sole proprietorship, then the lender can place a lien on your home. Meaning, if you don’t pay back your loan in the agreed upon time, the lender may collect the unpaid debt by seizing your house.
- If you have personal savings: In the event you find yourself in a lawsuit, your savings and investments are the fastest and easiest things to lose if you’re found liable.
- If you offer financial counseling: Your personal money and belongings are vulnerable in a lawsuit if a client feels they’ve lost money due to your advice.
Learn how to start your business
NerdWallet has rounded up some of our best information on starting a business, including structuring and naming your company, creating a solid plan and much more. We’ll help you do your homework and get started on the right foot.
