Sole Proprietorship

A sole proprietorship is a business owned by a single individual that has not been formed as a separate legal entity such as a corporation or limited liability company. The owner, called the sole proprietor, receives all the profits, makes all the decisions and is personally responsible for all of the business's debts and obligations. It is the simplest and most common form of business organization in the United States, used by freelancers, consultants, tradespeople, small shop owners and many people with side businesses. It is often called simply a proprietorship.

In law, the business and the owner are the same person. In accounting, however, the business's records are kept separate from the owner's personal finances, following the economic entity assumption. This lets the owner measure the business's own profit and financial position.

• Formation: there is usually no registration needed beyond local business licenses and, if the business uses a name other than the owner's, a fictitious or assumed name filing, often called a DBA.
• Liability: the owner has unlimited personal liability. Creditors and people who win lawsuits against the business can claim the owner's personal assets, such as savings and, subject to state exemptions, a home. This is the main difference from a limited liability company or corporation, which offer limited liability.
• Control and continuity: the owner controls everything, but the business generally ends when the owner retires or dies, and it cannot sell shares to raise capital.
• Financing: funding comes from the owner's savings, personal borrowing and retained profits, which can limit growth.

A sole proprietorship is not taxed separately. Its profit or loss is reported on Schedule C of the owner's individual Form 1040 and taxed at the owner's personal income tax rates, whether or not the money is withdrawn from the business. This avoids the double taxation of corporate profits and dividends. The owner also pays self-employment tax, 15.3 percent on net earnings up to the Social Security wage base and 2.9 percent above it, covering both the employer and employee shares of Social Security and Medicare. Sole proprietors may use their Social Security number for tax purposes but need an employer identification number if they hire employees. Many may qualify for the federal deduction for qualified business income.

A sole proprietorship has no stock and no retained earnings account. Owner's equity is recorded in a single capital account, often named after the owner, with a separate drawing account for withdrawals. The owner is not an employee, so money taken out for personal use is a drawing, not salary expense.

Suppose Maria starts a bookkeeping practice by depositing $15,000 of her own money in a business bank account. The entry debits cash and credits Maria, capital. During the year the business earns net income of $62,000, and Maria withdraws $40,000 for living costs, recorded by debiting Maria, drawing and crediting cash. At year end, closing entries transfer net income to the capital account and close the drawing account to it. Ending capital is:

Here beginning capital is zero, investments are $15,000, net income is $62,000 and drawings are $40,000, giving ending capital of $37,000. A statement of owner's equity shows these movements, in place of the statement of retained earnings used by corporations. Maria owes income and self-employment tax on the full $62,000 profit, not just the $40,000 she withdrew.

Owners often move from a sole proprietorship to an LLC or corporation as the business grows, mainly to protect personal assets, add partners or investors, or manage taxes. Two or more owners operating without incorporating form a general partnership rather than a sole proprietorship. A single-member LLC is treated by default like a sole proprietorship for federal income tax, a so-called disregarded entity, while still providing liability protection under state law. Insurance can reduce, but not remove, the liability risk of operating as a sole proprietor.

• Internal Revenue Service