What is a sole proprietorship? Liability, taxes and when it stops fitting

What is a sole proprietorship?

A sole proprietorship is a business that one person owns and runs without forming a company. The IRS defines a sole proprietor as someone who owns an unincorporated business by themselves. No filing creates it: the SBA says you’re automatically considered to be a sole proprietorship if you do business activities but don’t register as any other kind of business.

That makes it the default for makers. Example: you sell candles at weekend markets and through an online shop, and you have never registered an LLC or a corporation. You are running a sole proprietorship under your own name.

The owner and the business are not separate. The SBA says sole proprietorships do not produce a separate business entity, which means your business assets and liabilities are not separate from your personal assets and liabilities. You can still trade under a brand name: the SBA notes that sole proprietors are still able to get a trade name. That name is registered as a DBA, short for doing business as, and the SBA says most states require you to register your DBA if you use one. A DBA doesn’t give legal protection, but it might be legally required.

A one-owner LLC is a different structure. For federal tax, the IRS says that if you are the sole member of an LLC and elect to treat it as a corporation, you are not a sole proprietor.

Sole proprietorship liability: business debts are personal debts

Liability is the main trade-off. Because the business is not a separate entity, the SBA says you can be held personally liable for the debts and obligations of the business.

Example: if the business owes a supplier or loses a lawsuit, that debt is yours, not only the business account's. A separate business bank account helps keep records apart, but it does not change who is liable.

How much this matters depends on what you sell and what could go wrong with it. A candle or a skin cream can injure someone in a way a digital download cannot. The SBA describes the sole proprietorship as a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.

An LLC is the structure the SBA describes for separating the two. It says LLCs protect you from personal liability in most instances: your personal assets won’t be at risk in case your LLC faces bankruptcy or lawsuits.

Sole proprietorship taxes: how sole proprietors are taxed

Income tax on Schedule C. The business pays no income tax of its own: the SBA notes that, unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. You report business income or loss on Schedule C (Form 1040 or 1040-SR), Profit or Loss from Business, and the result flows onto your personal return, Form 1040, U.S. Individual Income Tax Return. The IRS treats an activity as a business when your primary purpose for engaging in the activity is for income or profit and you are involved in the activity with continuity and regularity.

Self-employment tax. On top of income tax, sole proprietors pay self-employment tax, which the IRS describes as a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. The rate is 15.3%: 12.4% for social security and 2.9% for Medicare. You owe it, and file Schedule SE (Form 1040), Self-Employment Tax, when net earnings from self-employment are $400 or more. The IRS lets you deduct the employer-equivalent portion of your self-employment tax in figuring your adjusted gross income.

Estimated tax payments. The IRS says taxes must be paid as you earn or receive income during the year, either through withholding or estimated tax payments, and if you are in business for yourself, you generally need to make estimated tax payments. The rule generally applies if you expect to owe $1,000 or more when you file, and the payments cover not only income tax, but other taxes such as self-employment tax. The IRS divides the year into four payment periods, and you figure the payments on Form 1040-ES, Estimated Tax for Individuals. If you don't pay enough by each period's due date, you may be charged a penalty even if you are due a refund when you file your income tax return.

This page is general information, not tax advice. It describes federal rules. State income tax, sales tax and local business taxes vary by state and city. Tax figures and thresholds were checked against IRS pages on 3 Oct 2026.

Filing taxes as a sole proprietor in your first year

These steps cover the federal rules a new sole proprietor meets in the first year.

1. Keep records from the first sale

   Schedule C reports business income and expenses, so record every sale, fee, refund and supply purchase as it happens. Marketplace reports help, but they leave out cash sales and costs you paid personally.

2. Expect a Form 1099-K from some platforms

   A payment app or online marketplace, including a craft or maker marketplace, must send you a Form 1099-K if your payments for goods or services total over $20,000 in more than 200 transactions. The IRS adds that they may send you a Form 1099-K with lower amounts and/or transactions. If customers pay you directly by card, your card processor sends one no matter how many payments you got or how much they were for. Your copy is due by January 31.

3. Report all income, with or without a form

   The IRS says that if you receive payments for selling goods or services, you must report all income on your tax return. When a Form 1099-K does arrive, the IRS says to use Form 1099-K with other records to help you figure and report your taxable income.

4. Decide on estimated payments

   If you expect to owe $1,000 or more, plan a payment for each of the IRS's four payment periods. The IRS says most taxpayers avoid the underpayment penalty if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller; there are special rules for farmers, fishermen, and certain higher income taxpayers. You don't have to pay estimated tax for the current year if you meet all three of the IRS's conditions, including that you had no tax liability for the prior year.

5. File Schedule C and Schedule SE with your return

   Attach Schedule C (Form 1040 or 1040-SR), Profit or Loss from Business, and Schedule SE (Form 1040), Self-Employment Tax if it applies, to Form 1040, U.S. Individual Income Tax Return.

Sole proprietorship advantages and disadvantages

The pros and cons of a sole proprietorship come from the same fact: there is no separate business. That makes it easy to start and simple to run, and it leaves the owner personally exposed.

When a sole proprietorship stops fitting

Another structure is worth a look in these situations.

• You sell something that could hurt someone, or you have savings or a home you want to protect. The SBA describes LLCs as a good choice for medium- or higher-risk businesses, owners with significant personal assets they want protected.
• You bring in a partner. The SBA says partnerships are the simplest structure for two or more people to own a business together.
• You want investors or a bank loan, which the pros and cons table lists as a weak point of the structure.
• Your profit has grown and you want to compare tax treatments. An LLC alone does not remove self-employment tax: the SBA says members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security. S corp status needs its own filing: the SBA notes that S corps must file with the IRS to get S corp status.

Switching later is possible, with conditions. The SBA says that while you may convert to a different business structure in the future, there may be restrictions based on your location. It adds that this could also result in tax consequences and unintended dissolution.

Rules differ from place to place: the SBA notes that ownership rules, liability, taxes, and filing requirements for each business structure can vary by state. This page is general information, not legal or tax advice.

Where Nation fits

Questions about sole proprietorships