Meet the owners draw, whether you're a sole proprietorship, LLC, or partner.

Know The Basics: Sole Proprietorship Advantages & Disadvantages

Posted October 5, 2015 by Jacob Donelly in Running a Business 101
Forming a sole proprietorship is one of the easiest ways of starting a business, but there are disadvantages to using this structure.

We've built a handy reference sheet that outlines how business owners are paid. Download it for free here.

One of the easiest types of businesses that an individual can set up is a sole proprietorship. As the name implies, this is a business that is owned by a single individual.

However, unlike other types of corporate structures — like LLC, S-Corp, and C-Corp — a sole proprietorship is unincorporated.

What this means is that a sole proprietor owns the entire business, is entitled to all of the profits. But is also responsible for all the debt, liabilities, and losses that may occur. 

Forming a Sole Proprietorship

There is no legal structure when forming a sole proprietorship. Unlike a LLC, which requires you to file papers with your state’s Secretary of State and then to publish in a newspaper, a sole proprietorship exists once you start doing business. I own a sole proprietorship because I am the only owner of my freelance writing career.

Once you have decided that you are going to do business, you’ll need to ensure that you have the correct licenses and permits for both the federal and local governments. The SBA has a great tool for determining what licenses and permits you’ll need. 

The final thing that is important to remember is the business name. If you are just going to act in your own name, this isn’t important. But if you want to act under a different name, you’ll need to get what’s known as a “DBA” or “Trade Name.” This allows you to operate under that name rather than your own.

Sole Proprietorship Taxes

Because you are operating as your own business, taxes are very straight forward. You’ll need to fill out the following tax forms:

  • Form 1040: Income Tax Return
  • Schedule C (Form 1040): Profit or Loss from Business
  • Schedule C-EZ (Form 1040): Net Profit from Business
  • Schedule SE (Form 1040): Self-Employment Tax
  • 1040-ES: Estimated Tax for Individuals 

There are other forms, but for the most part, if you don’t have employees, the above are the ones that you need to be aware of for sole proprietorship taxes. That being said, it is always advisable to talk to an accountant to ensure that everything is squared away.

Advantages of Sole Proprietorship 

The sole proprietorship advantages are numerous. They're relatively straightforward to up, for starters. Because there is no formal process with local governments, you don’t need to wait to start operating your business. Equally, there are no real costs associated with getting started.

Taxes are easy to accomplish with sole proprietorships as well. If you’ve ever done taxes online, it’s just one additional step. In comparison to running a legal corporation, there is not that much work associated with doing your sole proprietorship taxes.

Disadvantages of Sole Proprietorship 

On the other hand, there are disadvantages to running a sole proprietorship.

The first is the liability. If I had an employee that happened to get injured, I would have no protection against any law suits. A corporation adds a layer between me and the employee, which means that the business gets sued, not me.

Sole proprietorship liability also has to do with debt. If I invest in a new idea and it fails, any debts that I have accrued are tied to me. If I filed for bankruptcy, all of my personal assets could be up for grabs. If my business was incorporated and the business had to file for bankruptcy, my personal assets would be safe from seizure.

The other disadvantage is the inability to raise money. Investors won’t even consider your business because the structure is not conducive to a successful fundraising. Investors are literally buying a piece of your business when they invest, but a sole proprietorship doesn’t have stock to sell; therefore, investors can’t own anything.

Is a Sole Proprietorship Right for Me?

There are a two questions to ask yourself if you’re looking to start a business and don’t know if you should go the route of sole proprietorship or something more formal.

  1. Do I need to raise money? If so, you may want to go the route of something more formal because investors won’t be interested. If not, a sole proprietorship is sufficient.
  2. Will I need employees? If so, the added liability protection that comes from a corporation or LLC is better for you. If you’re a freelancer, a sole proprietorship is sufficient.

The good news is that Justworks can work with sole proprietors and corporations. If you have freelancers and want a straight forward way to handle paying them, just use the platform to process payroll at your schedule.

And at the end of the year, Justworks will ensure that the correct tax forms get to those contractors as well as the IRS.

How do business owners get paid?

Get the Guide

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.