What Is a Sole Proprietorship?

By Kristi Waterworth – Updated Dec 16, 2024 at 1:49 PM

Key Points

A sole proprietorship is easy to start as it requires minimal paperwork and no special tax forms.
Personal assets are at risk in a sole proprietorship since the owner and business are legally one entity.
Switching from a sole proprietorship to an LLC can protect personal assets and involves simple procedures.

Starting a business means asking yourself a lot of important questions about what your business will be, including how it will be structured. If you're considering a sole proprietorship, this article is for you.

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A person working behind the counter of a pet accessories store. — Image source: Getty Images.

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EIN

One of five taxpayer identification numbers that usually consists of a nine-digit sequence and serves as a unique identifier for businesses.

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About the Author

Kristi Waterworth has been a contributing real estate and financial expert at The Motley Fool, covering real estate, investing, and personal finance topics, since 2020. Kristi has been interviewed by various TV media outlets and podcasts for her real estate investing expertise – from residential real estate to digital real estate and everything in between. Kristi’s journalist career spans over 25 years, and she has written about real estate investing, homeownership, and home construction specifically for the last decade. She was also previously a licensed Realtor and general building contractor before the Great Recession and housing market collapse. She holds a bachelor’s degree in American history from Columbia College in Missouri.

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1. Legal protection

This is probably the most important factor when choosing which form for your business to take. In an LLC that is being run properly (that means, especially, no co-mingling of funds), the owner of the business isn't liable for legal issues that may arise from the business.

So, for example, let's say that your company is a pet taxidermy business. You taxidermy someone's pet as a memorial, but you lose the irreplaceable finished product, and you get sued by the pet owner (your client). You aren't personally liable for that issue; your business holds all the liability. Business assets can be encumbered by the lawsuit, but your personal home, for example, can't be pulled into it.

2. Taxes

Sole proprietorships are, by default, pass-through tax vehicles. You and the business are the same entity, so there's no additional layer of taxation possible. This isn't the case for an LLC, which can and may elect to pay corporate taxes for many different reasons.

3. Formation

LLCs are legal entities. This means you'll likely need a lawyer or a few weeks of hard study if you attempt to do it yourself. You'll also have additional steps involved, like registering your business name with the state and filing your LLC before you can get started working.

Sole proprietors, in effect, will their businesses to life. You may need a business license or to register a trade name, but this stuff is simple and can take a day or two, which is nothing compared to the wait on an LLC filing during busy times.

4. Maintenance

Sole proprietorships only need to pay their taxes and renew their licenses, if applicable. LLCs, however, will need to do that, plus file annual reports (your lawyer can do this for a fee) and hold membership meetings, at the minimum. It just adds up to more expense if you don't really need an LLC for your business.

This is not to say that either an LLC or a sole proprietorship is a better business model. Both have places in the business world and often in the life cycle of an individual business. But they are different, and it's important to understand what you're getting into before you choose.

What Is a Sole Proprietorship?

Key Points

EIN

Related investing topics

Retirement Plans Options for the Self-Employed

How to Start a REIT

How to Legally Start a Hedge Fund in the US

Profit and Loss Statement

About the Author

Our Guides

Premium Investing Services

Retirement Plans Options for the Self-Employed

How to Start a REIT

How to Legally Start a Hedge Fund in the US

Profit and Loss Statement