A sole proprietorship is the most common structure chosen to start a business in the United States because it is the simplest one to form. It is an unincorporated company that’s owned and operated by a single individual. There is no distinction between the person and their business, which means you are entitled to receive all of the profits while also being responsible for every debt, loss, and liability.
Although there are some exceptions (notably Washington State), you do not need to take any formal action to form a sole proprietorship. Assuming that you are the only owner of the company, this status comes automatically from your commercial activities. Many people already own this kind of business without realizing it. If you sell something from a hobby that you do or work as a freelancer, then you are a sole proprietor.
As with every other business type, you must obtain the necessary permits and licenses to operate. Regulations are different within each industry, and every jurisdiction has specific rules that you must follow. If you choose to operate under a name different than your given one, then you’ll need to file for a DBA with your state that’s an original moniker.
Several advantages and disadvantages of a sole proprietorship are worth considering if you’re thinking about going into business for yourself.
List of the Advantages of a Sole Proprietorship
1. There are very few legal formalities to worry about with a sole proprietorship.
When you start a sole proprietorship, then there is a minimal amount of paperwork that you must file to begin commercial activities. Only a handful of legal formalities are necessary, and these are typically found in your local jurisdiction’s rules. That is the complete opposite of a partnership or corporation, where are you must prepare a series of documents and submit them to the government and regulatory agencies.
You can form a sole proprietorship by filing with the local office in your city or county in most situations. Some areas don’t even require you to do this if you plan to be self-employed.
2. You don’t need to create a trade name for yourself.
A sole proprietorship is like a commercial extension of who you are. That means it is not necessary to go through the hassle of setting up a separate trade name with business accounts when you pursue this business structure. You can proceed to conduct transactions using your given name. Even if someone has the same name as you do in a similar industry, this benefit does not go away.
You still have the option to create a DBA if you prefer. A small filing fee with your local government body is usually necessary if you decide to go in this direction.
3. Few startup costs are necessary when starting a sole proprietorship.
A sole proprietorship doesn’t cost much to get started in most areas. Although it is not entirely free, the legal fees that you need to pay to conduct business are usually minimal. The licenses and permits are typically less than $100 each. Even if you don’t have local customers or collect sales tax from your activities, there are still specific costs with the formation of a sole proprietorship that you must consider, such as equipment, inventory, and staffing.
4. You don’t need a minimum amount of capital to get started.
A sole proprietorship isn’t like other business formats where a minimum amount of capital is needed to begin operations. You can get started with whatever happens to be in your bank account right now. Although investors don’t usually provide resources to people operating under this business structure, you don’t need to worry about managing equity or appeasing shareholders. There isn’t even a partner to whom you need to answer when using this structure for your new company.
5. The sole proprietor has absolute power over the decision-making process.
When you own a business using this structure, then you are in control of every decision that must be made. That’s because you are the only one who is running the company. That means you get to avoid the headache of obtaining approval through a board of directors or the consent of other partners. This advantage also reduces the amount of time it takes between arriving at a choice and implementing it.
Operating as a sole proprietorship removes most delays and gridlock that you typically encounter when working in a bureaucratic environment. Because you are calling all of the shots, it is much easier to move forward with a change in this business structure.
6. Sole proprietors have sole discretion for their business costs.
Owners of a sole proprietorship are the only ones who hold the purse strings of their company. Some exceptions do apply in a few jurisdictions where a spouse or registered domestic partner may also have some power. Either way, it is up to the individual operating the company to allocate costs and utilize resources efficiently. This advantage is not something that is possible in a partnership or corporate setting because costs are subjected to a series of oversight choices by every stakeholder.
7. You get to enjoy all of the profits with a sole proprietorship.
The sole proprietorship structure does not differentiate between personal and business finances. That means all of the profits from your company become your personal income. If you were operating in a partnership or a corporation, then this benefit is not possible. You’d have to split the net income after-tax amongst everyone. Since you’re working by yourself, you get to take everything.
8. There is less government control in place over this business structure.
The people who operate under a sole proprietorship are only subjected to a handful of regulations in the United States. This benefit becomes immediately noticeable when you start setting up the company in the first place. Most owners only need to take a simple trip to the local business office to ensure the registration is complete. You’re not required to submit a lot of documentation to any regulatory or government agencies.
Sole proprietors aren’t bound by the same guidelines that govern partnerships and corporations. Most people have the option to run their business in whatever manner they deem fit.
9. Some sole proprietorships can experience tax advantages.
You only need to file one tax return in the United States if you work as a sole proprietor. This benefit remains possible even if you work a full-time job and your company is a side hustle. You aren’t free from paying taxes on the income that you earn commercially, but there is only one income figure to report. Whatever you receive gets taxed at a lower rate, although you may need to reach the limits of Social Security contributions before reaching this status.
You’re not required to attach a balance sheet of the business to file your federal taxes in the United States with a sole proprietorship. Some states may require you to keep books, so you’ll want to talk about what is necessary when you register your company.
10. Sole proprietors have the least amount of recordkeeping.
You aren’t required to keep your personal and business accounts separate when operating as a sole proprietor. Although it is easier to file your taxes sometimes with different books, the recordkeeping in this business structure is simple and straightforward. Most people can do the work themselves.
You aren’t required to present a formal financial statement beyond what is necessary for taxation purposes. There aren’t any meetings where you must take minutes to file when using this structure. It’s like having a regular job, but with a few extra reporting requirements.
11. It is easy to dissolve a sole proprietorship if it becomes necessary.
If you decide that the ideas you’re pursuing aren’t profitable as a sole proprietorship, then the process of dissolving your business is quite simple. Once you choose to stop operations, then all you need to do is pay off any debt or obligation the company incurred. Then you need to notify the tax authorities that you’re no longer conducting commercial operations so that they know not to expect a return from you in the next fiscal year.
You’ll still need to file taxes on your income for the current year. If you end up having a loss from those activities, then it will lower your personal income to a potentially lower income bracket.
12. Sole proprietors can deduce the employer-equivalent portion of their taxes.
Although taxation can be a problem for some sole proprietors, there is at least one bright spot in that issue. You do have the right to deduct the employer-equivalent portion of your self-employment tax obligations from your adjusted gross income. This deduction only impacts your income tax, so it doesn’t apply to your net earnings from your business activities.
Some sole proprietors might qualify to claim the Earned Income Tax Credit because of this structure. You’ll need to file using Form 1040 Schedule C. You can also take a deduction for income tax purposes for the cost of health insurance using Form 1040 and Schedule SE instructions.
13. You can grow to whatever size you prefer as a sole proprietor.
Because you are in charge of all of the business decisions, the scalability of your company is entirely up to your preferences. You can decide to keep operations small so that you have more flexibility with your schedule, or you can also pursue a bigger opportunity so that your income levels rise.
As your company grows, there is nothing that says you have to do all of the work by yourself. Your business has the right to hire employees when you file for the status with the IRS and your local government. You’ll still face all of the liability issues of the structure, so it is often advisable to incorporate when you reach a certain size so that your personal assets can receive a measure of protection.
List of the Disadvantages of a Sole Proprietorship
1. Sole proprietors have unlimited personal liabilities.
A sole proprietor might get the benefit of enjoying all of the profits from commercial activities, but they are also left to manage every liability and all of the losses that might occur. Unlike an LLC or a corporation, the sole proprietorship structure is not a separate legal entity. That means there is zero liability protection. Every obligation from the company is also one that carries a personal guarantee with it.
If the company incurs significant losses or receives a judgment against it, then creditors have the right to pursue the sole proprietor’s personal assets. Everything is at risk in the scenario, including the house, vehicles, and other real properties. You can lose practically everything if an idea isn’t successful.
2. It is an uncertain business life when operating as a sole proprietor.
The continuity of the business is an uncertain issue when a company operates as a sole proprietorship. Because the owner and the organization are a single entity, then any impairment renders the individual from being able to manage commercial operations or make decisions. That means cessation happens automatically, often dissolving the company.
This structure gives owners a lot of flexibility when managing their business, but it also creates a fragile foundation. If you get sick as a sole proprietor, then that one illness might put you out of business.
3. Most lenders won’t provide financing packages to sole proprietorships.
When you operate as a sole proprietor, then it is your personal credit score that provides the foundation for a lending offer. If your financial situation isn’t in a good place, then it will be almost impossible to obtain any financing to expand your operations. The lenders that will provide you with opportunities will charge much higher interest rates, which means it will cost more to get things done.
Most sole proprietorships find that the availability of working capital for their business is directly limited to the funds that are available in savings.
4. Less diversity exists in the leadership team because there isn’t one.
The companies that have a diverse leadership team typically have the most success in their industry. Sole proprietors don’t have access to that benefit because they are the only ones making decisions for their company. Even if a spouse or children have permission to get involved with commercial activities, there isn’t an outside perspective available with this business structure.
Being the only one who can make a choice can be a heavy burden for some sole proprietors. Since the success or failure of the company comes down to the individual, the people who see the most opportunities with this business structure tend to have higher levels of confidence and grit.
5. Sole proprietors get hit with double taxation.
Although a sole proprietorship benefits from pass-through income that often gets taxed at a lower rate, this business structure faces a unique method of double taxation. Individuals and companies must each pay Social Security and Medicare taxes on most wages. This disadvantage applies to the first $132,900 of your combined earnings, and then the Medicare component doesn’t have a cap. Since you’re self-employed, you get to pay both portions of that tax.
If you are a low-income freelancer, then this issue can hit you hard in the checking account each quarter. The current rate in the United States is 15.3%. Since you pay taxes as income gets earned, sole proprietors must pay estimated taxes each quarter or face the possibility of fines or penalties for underpayment.
6. Some sole proprietorships don’t seem like they are a business.
Because a sole proprietorship is not a separate legal entity, it can be viewed as a business that lacks professionalism. Some people don’t even see it as a company. This disadvantage occurs most often because you don’t need to go through the same rigid procedures that partnerships and corporations go through during their first days of setting up. The informality of it all can make it unappealing for some potential customers.
7. Sick days and paid vacations aren’t part of the package as a sole proprietor.
If you work full-time for most employers, then one of the benefits that you receive is paid time off for vacations or when you are sick. Paid holidays are another potential advantage of the traditional working relationship. A sole proprietorship doesn’t get this opportunity at all. If you are the owner of this company, then skipping a day of work because you are sick results in a lack of income. The same truth applies to time spent on vacation.
That means you need to budget for these circumstances out of your current income. Since many sole proprietors scrape by on minimal profitability, paid time off is a luxury that most are unable to afford.
8. You will work harder and longer than ever before as a sole proprietor.
If you thought that a 40-hour workweek was a lot of time and pressure, then operating in the world of sole proprietorships is going to be a rude awakening. The only way for you to be successful is to work harder and longer with a better quality outcome than what your competitors provide. It is not unusual for people operating in this situation to work seven days per week, often eclipsing 60 hours. Even with all of that sweat equity, there still isn’t a guarantee of a successful outcome.
9. You are completely on your own with this business structure.
Most sole proprietors are self-employed individuals who typically work from home. It can be advantageous to be making all of the decisions, but it also gets lonely in that situation. About 70% of people who earn a full-time income using the structure say that the overall lack of human contact is one of the biggest disadvantages of working this way.
You can always work from a coffee shop or another social location, but that isn’t the same as having the chance to take a break to network with other co-workers. Work-sharing spaces are a popular way for sole proprietors to connect if they have enough money available. At the end of the day, it’s still going to be you against the world with this business.
A sole proprietorship allows you to explore different commercial ideas without making a significant time or monetary investment. It is a simple way to test the marketplace to see if your goods or services have an opportunity to make a positive impact. If they do, then you can always decide to form an LLC or incorporate the organization at a later date.
Sole proprietors get to call their own shots while pursuing a career that suits them well. Even with the challenges that exist when using this business structure, most people say that the experience of operating in this way was one that was quite rewarding.
The advantages and disadvantages of a sole proprietorship show that this opportunity is it right for everyone. If you have an independent spirit and aren’t afraid of the self-employment taxes in the United States, then this option can help you to reach your full potential.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.