Sole Proprietorship: Pros, Cons, Taxes & When to Switch

Starting a Business as a Sole Proprietorship

Starting a sole proprietorship is popular among small brick-and-mortar, service-based, and online businesses. Because it’s the easiest structure to start, it’s also one of the most common choices for new business owners.

This article covers the pros and cons of a sole proprietorship, how the taxes work, and the signs it’s time to switch to an LLC or corporation.

Laws and tax requirements for sole proprietorships vary by country and jurisdiction, so consult with a lawyer, CPA, or bookkeeper before you start. A quick conversation with a professional up front can save you from costly mistakes later.

Key Points and Facts About Sole Proprietorships

A sole proprietorship is the simplest business structure: you and the business are legally the same entity, and there’s no state registration required to start operating.
Sole proprietorships account for a large share of U.S. businesses — 31 million tax returns reported nonfarm sole proprietorship activity for tax year 2022, generating $410.7 billion in total profit (IRS, Statistics of Income Bulletin, Spring 2025).
You’ll pay self-employment tax — 15.3% — on your net earnings once they exceed $400 for the year, in addition to regular income tax.
You can operate under your own name for free, or file for a DBA (“Doing Business As”) if you want a different business name.
Most owners eventually convert to an LLC or corporation once profit, liability risk, or the need for partners or investors grows.

The Pros and Cons of Starting a Sole Proprietorship

The Pros of Starting a Business as a Sole Proprietorship:

Easy To Start:

Becoming a sole proprietor is as easy as opening your doors for business. No registration is necessary for starting this type of entity. You don’t need to focus on structuring your business — you only need to focus on running it.

Even though you don’t have to register the business itself, you may still need a business license depending on what you’re starting. Contact your local municipality to find out if a license is required.

AI isn't optional anymore. Start with one small step.

As a sole proprietor, you and the business are one entity from a legal and tax perspective, and you’d operate under your personal name by default. If you’d rather use a different business name, you can apply for a DBA, which means “Doing Business As.” With a DBA, you keep the sole proprietorship structure but operate under a name other than your own — as long as that name is available for registration.

You Can Start Your Business as a Trial Run:

Because a sole proprietorship is so easy to start, it lets you test a business idea without investing a lot of money upfront. If your idea requires significant startup cash, though, you may not save much by staying a sole proprietor, and it might make more sense to register as an LLC or corporation from the start.

You Can Change Your Business Structure Later:

You can always start as a sole proprietorship and convert to an LLC or corporation once your business gains traction. Several well-known companies began this way, including:

eBay — founded as a sole proprietorship called AuctionWeb by Pierre Omidyar in 1995
Kinko’s — founded by Paul Orfalea in 1970, it grew to more than 1,200 locations before being sold to FedEx
J.C. Penney — James Cash Penney started as an employee in a small retail chain in 1898, later bought out his partners, and ran the business as a sole proprietor for a number of years before incorporating in 1913
Walmart — Sam Walton’s earliest stores in Arkansas operated as sole proprietorships in the 1950s and 60s
Sears — Richard Warren Sears started out selling watches by mail order as a sole proprietor before partnering with Alvah Roebuck
Marriott Hotels — J. Willard Marriott opened an A&W root beer stand as a sole proprietorship in 1927, decades before the hotel chain itself launched in 1957

Many of these companies have since been acquired, restructured, or closed in their original form — the point isn’t that they’re all still running the same way today, but that a sole proprietorship can be a legitimate starting point for a business of any size.

Easy To Walk Away:

Another advantage of starting a business as a sole proprietorship is that it’s easy to walk away if it doesn’t work out. As long as you take care of any debt you acquired, you can consider the business closed.

Complete Control:

As a sole proprietor, you’re in control of the business and you make the decisions, unlike running a business with partners, where decisions need their approval. Even with controlling voting shares in a partnership, good business practice means discussing major decisions with your partners anyway.

The Cons of Starting a Business as a Sole Proprietorship:

No Asset Protection:

As a sole proprietorship, you and the business are one entity, so you’re liable for all its debt. If you end up in enough debt to declare bankruptcy, you could lose your personal assets — your house, your car, anything you own — because the law doesn’t separate you from the business.

The same is true if you’re hit with a commercial lawsuit: your personal assets are on the line. A lawsuit against an LLC or corporation, by contrast, can only go after the business’s assets, because those structures legally separate the owner from the company.

Hard To Get Funding:

A sole proprietorship is associated with being a small startup, which makes it difficult to get funding from a financial institution. Many lenders see a sole proprietorship as a business still finding its footing rather than an established one, and they price that risk accordingly.

You’d likely need to seek funding as a personal loan instead, and even then, a lender may turn you down if they view the underlying business as too high-risk. Banks profit from interest on loans that get repaid; foreclosing on a borrower’s assets is a costly, time-consuming process for them, not a source of profit.

No Partners Allowed:

As a sole proprietorship, there must be only one owner. You can’t have a business partner as a sole proprietorship — you’ll need a different structure if you plan to bring one or more partners on board.

You Can’t Have Investors:

As a sole proprietorship, you can’t attract investors, because investors typically want a formal contract and a stake in the business. If you want to offer shares, you’ll need to register a different structure, such as a corporation.

Sole Proprietorship Tax Implications

The IRS treats you and the business as one entity, so all profits from the business are taxed as your personal income. If you have a job on top of running a sole proprietorship, you’re taxed on both your job income and your business profit.

On top of regular income tax, you’ll also owe self-employment tax — 15.3% — once your net self-employment earnings exceed $400 for the year. This covers the Social Security and Medicare contributions that an employer would normally split with you as a W-2 employee.

Your bookkeeper or accountant can fill in the appropriate tax forms for you. In the U.S., that’s a Schedule C. Tax rules for sole proprietors can differ depending on where you’re operating, so check with a professional familiar with your local requirements.

When Should You Switch From a Sole Proprietorship to Another Entity?

Attracting Investors:

If it’s time to attract investors to increase funding, it’s time to switch from a sole proprietorship to an LLC or corporation — an investor can’t take a stake in a business that, by definition, can only have one owner.

Looking For Partners:

Whether you’re considering a partner for a strategic alliance or to bring in more funding, you’ll need to change your business structure first, since a sole proprietorship can only have one legal owner.

Increase in Risk:

If you’re gaining traction and dealing with products or services that carry real lawsuit exposure, that’s a sign to become an LLC or corporation to protect your personal assets.

Starting To Make a Sustainable Profit:

As your profit grows, switching structures can start to make financial sense, though CPAs don’t agree on one exact number. Some put the break-even point at net profit consistently exceeding $40,000 a year; others place it higher, at $50,000–$80,000, since the payroll compliance costs involved (roughly $600–$1,500 a year) need to be weighed against the self-employment tax savings. Below that range, the added complexity usually isn’t worth it.

Your accountant or CPA can run the numbers for your specific situation and tell you when the switch actually pays off — consult with one once your business starts turning a real profit.

Action Steps for Starting a Sole Proprietorship

Decide If a Sole Proprietorship Fits Your Situation

Weigh the liability risk of your specific business against the simplicity of skipping registration.
Consider whether you’ll need outside investors or business partners soon — if so, a sole proprietorship won’t work.

Confirm Your Legal and Tax Requirements

Consult a lawyer, CPA, or bookkeeper about the rules that apply in your specific city, state, or country.
Decide whether you’ll handle your own bookkeeping or bring in a professional from the start.

Decide When To Reassess Your Structure

Set a reminder to revisit your structure once your net profit starts approaching the $40,000–$80,000 range.
Watch for signs — new investors, new partners, or rising lawsuit exposure — that mean it’s time to convert sooner.

Checklist for Starting a Sole Proprietorship

Confirm licensing requirements
- Contact your local municipality to check if a business license is required
Choose your business name
- Operate under your own legal name, or file a DBA if you want a different business name
Set up your bookkeeping
- Line up a bookkeeper or accountant to handle your Schedule C and self-employment tax filings
Separate your finances where possible
- Open a dedicated business bank account, even though the law doesn’t require it, to keep records clean
Know your exit signals
- Keep the investor, partner, risk, and profit thresholds above in mind so you know when it’s time to convert

FAQ: Starting a Sole Proprietorship

Do I need to register a sole proprietorship?

No state or federal business registration is required to start operating, though you may still need a local business license depending on your type of business.

Can a sole proprietorship have employees?

Yes — a sole proprietorship can have employees. What it can’t have is business partners or shareholders, since it’s limited to one owner.

How is a sole proprietorship taxed?

Business profit passes through to your personal tax return and is reported on Schedule C. You’ll also owe 15.3% self-employment tax on net earnings above $400 for the year.

When should I switch from a sole proprietorship to an LLC?

Common triggers include bringing on investors or partners, rising lawsuit risk, or net profit consistently landing somewhere in the $40,000–$80,000 range, where an LLC or S-corp election can start to save on self-employment tax (the exact break-even point varies by CPA).

Conclusion:

You now have an overview of what it means to start a business as a sole proprietorship — the pros, the cons, the tax basics, and the signs it’s time to move on.

Consult a knowledgeable CPA before you start so they can advise you on the right route for your specific business.

References:

How to Register Your Business Using These Resources
How to Choose a Business Structure Using These Tips

Business Structures

How To Register a Business Partnership: See These Important Details
How To Form an LLC: All About Limited Liabilities Companies
How To Form a Corporation: Important Points To Consider
Here Is How To Choose a Business Registration Service
LLC vs. Sole Proprietorship

Business Name

How To Choose a Business Name Using These Proven Tips
How To Register a Business Name Using These Unique Tips
How To Register a Domain Name For Your Business

Starting a Business as a Sole Proprietorship: Pros, Cons, and When to Switch