A sole proprietorship’s structure and taxes are unusually simple: one person owns and runs the business as themselves, with no separate legal entity between the owner and the work, so all profit flows straight onto the owner’s personal Form 1040 and is taxed once at individual rates, plus 15.3 percent self-employment tax on net earnings. About 73 percent of U.S. businesses operate this way, which is why the rules matter to so many freelancers, contractors, and small shop owners.
You and the Business Are the Same Legal Person
A sole proprietorship has no legal identity apart from its owner. Business assets — equipment, inventory, office furniture — are held in your personal name rather than by a separate company. When you sign a lease or a contract for the business, you are personally on the hook. Money the business earns is your money. Money the business owes is your debt.
You can operate under your own legal name or register a trade name, often called a “Doing Business As” or DBA. A DBA is an alias, not a new entity. It does not put anything between you and the business.
Unlimited Personal Liability
Because there is no legal wall separating you from the business, creditors and anyone who sues the business can reach your personal assets — home, savings, car — to satisfy a business debt or a judgment.1U.S. Small Business Administration. Choose a Business Structure If a customer is injured on your premises, or a client claims your work caused them financial harm, a court can order payment from personal funds. The structure itself offers no shield.
Insurance is the main tool sole proprietors use to blunt this exposure. General liability, professional liability (also called errors and omissions), and workers’ compensation coverage where employees are involved are the common categories. When the potential liability is large relative to personal wealth, owners often convert to an LLC or corporation to get the legal separation a sole proprietorship cannot provide.
Who Runs It, and Hiring Employees
The management structure is as flat as it gets. You make every decision. There is no board, no officers, no required meetings, no resolutions. You set prices, choose what to sell, hire, and change direction without anyone’s approval.
Being the sole owner does not mean being the only worker. You can hire employees, and doing so brings federal obligations:2Internal Revenue Service. Hiring Employees
- Get an Employer Identification Number before paying wages. Your Social Security number alone is no longer enough once you have employees.
- Complete Form I-9 to verify each new hire’s identity and work authorization.
- Collect a Form W-4 from each employee so you withhold the right amount of federal income tax.
- Withhold and deposit federal income tax, Social Security, and Medicare, and pay the employer share of Social Security and Medicare.
State-level registration for unemployment insurance and workers’ compensation may also apply.
How the Income Is Taxed
The IRS treats a sole proprietorship as a “disregarded entity.” The business itself files no tax return and pays no tax. You report business revenue and deductible expenses on Schedule C (Profit or Loss From Business), and the net figure flows onto your personal Form 1040, where it is taxed at your regular individual rates alongside any other income you earn.3Internal Revenue Service. Topic No. 407, Business Income
This is pass-through taxation. It avoids the double taxation applied to C corporations, where the company pays corporate tax on profits and shareholders pay again on dividends. Sole proprietorship income is taxed once, on your return.
Self-Employment Tax
On top of income tax, sole proprietors owe self-employment tax to fund Social Security and Medicare. The combined rate is 15.3 percent: 12.4 percent for Social Security and 2.9 percent for Medicare.4Social Security Administration. If You Are Self-Employed An employee splits this with an employer. You cover both halves.
The Social Security portion applies only to net self-employment earnings up to $184,500 in 2026.5Social Security Administration. 2026 Cost-of-Living Adjustment (COLA) Fact Sheet The 2.9 percent Medicare portion has no cap. If your net self-employment income exceeds $200,000 (or $250,000 for married filing jointly), an additional 0.9 percent Medicare tax applies above that threshold.6Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates
You calculate the tax on Schedule SE and report it on Form 1040. You then deduct half of the self-employment tax as an adjustment to income on Schedule 1, which lowers your taxable income. Schedule SE is required if your net earnings from Schedule C are $400 or more.3Internal Revenue Service. Topic No. 407, Business Income
Quarterly Estimated Tax Payments
No employer is withholding tax from your business income, so the IRS expects you to pay throughout the year. Estimated payments are generally required if you expect to owe $1,000 or more in federal tax after withholding and refundable credits.7Internal Revenue Service. Estimated Tax
For the 2026 tax year, the four due dates are:8Internal Revenue Service. Publication 509 (2026), Tax Calendars
- First quarter: April 15, 2026
- Second quarter: June 15, 2026
- Third quarter: September 15, 2026
- Fourth quarter: January 15, 2027
Miss a deadline or underpay, and the IRS charges a penalty based on the shortfall, how long it went unpaid, and the applicable quarterly interest rate.9Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty You generally avoid the penalty if your payments cover at least 90 percent of the current year’s tax or 100 percent of the prior year’s (110 percent if your adjusted gross income was above $150,000).7Internal Revenue Service. Estimated Tax
Deductions That Lower the Tax Bill
Several deductions reduce what a sole proprietor actually owes.
Qualified Business Income Deduction
The Qualified Business Income deduction under Section 199A lets eligible sole proprietors deduct up to 20 percent of net business income before calculating income tax.10Internal Revenue Service. Qualified Business Income Deduction Originally scheduled to expire after 2025, it was made permanent by later legislation. The full deduction is available below certain taxable-income thresholds, and phase-in rules can reduce or eliminate it for higher earners, particularly in specified service fields such as law, consulting, and accounting. The thresholds are indexed for inflation, so check the current IRS figures when you file.
Self-Employed Health Insurance Deduction
If you pay for health insurance through the business and are not eligible for coverage under a spouse’s employer plan, you can deduct 100 percent of premiums for yourself, your spouse, your dependents, and your children under 27, even if those children are not your dependents for other tax purposes. The policy can be in your name or the business’s name. This is an adjustment to income, so it lowers adjusted gross income and you do not need to itemize to claim it. The deduction is not available for any month you were eligible to participate in a subsidized employer plan, even if you declined to enroll.11Internal Revenue Service. Instructions for Form 7206
Retirement Plan Contributions
Two retirement plans do most of the work for sole proprietors. A SEP IRA allows contributions of up to 25 percent of net self-employment earnings, capped at $69,000 for 2026, with tax-deductible contributions and no annual IRS filings.12Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs) A Solo 401(k) lets you defer up to $24,500 in 2026 as the “employee” and add up to 25 percent of net self-employment earnings as the “employer,” with a combined ceiling of $72,000; catch-up contributions raise those limits at age 50 or older.13Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs The Solo 401(k) generally allows larger contributions at lower income levels because of the employee deferral piece; the SEP IRA has less paperwork.
Setting One Up
You are already a sole proprietor the moment you start doing business as an individual. There is no formation filing to create the entity. A few practical steps clean up how you operate.
Choosing a Business Name
Working under your own legal name requires no filing. To use a different business name, file a DBA (also called a fictitious name or assumed name) with your county clerk or state business filing office. Fees generally run from about $10 to $100. Some states require you to publish the DBA in a local newspaper.
Getting an EIN
You need an Employer Identification Number if you plan to hire employees, open certain business bank accounts, or set up a retirement plan.14Internal Revenue Service. Instructions for Form SS-4 (Rev. December 2025) You can apply online at IRS.gov and receive the number immediately.15Internal Revenue Service. Get an Employer Identification Number If you do not need an EIN, your Social Security number works for tax filings. The application asks for your legal name, any trade name, business address, the reason for applying, and how many employees you expect in the next 12 months.16Internal Revenue Service. Form SS-4 (Rev. December 2025)
Licenses, Permits, and Sales Tax
Depending on your industry and location, you may need local or state licenses before you legally operate: a professional license, a food handler’s permit, a home occupation permit, or a general business license. Check with your city or county clerk and your state’s business portal. If you sell taxable goods or services, most states require a sales tax permit; you collect tax from customers and remit it on a schedule set by your state.
What Ends the Business
Because the entity is legally you, a sole proprietorship ends automatically when you stop operating or when you die. No separate entity survives the owner. If you want a successor to carry on, a will or trust must explicitly transfer the business assets and state your intent for the business to continue. Without that, the business simply ceases to exist. When you close voluntarily, the IRS still expects a final Schedule C for the year, Schedule SE if net earnings hit $400, and, if you had employees, final employment tax returns and W-2s.17Internal Revenue Service. Closing a Business Keep the records for at least four years.