According to TaxFoundation.org, there are more than
23 million sole proprietorships
in the U.S., making this
by far the most common type of business entity. Sole proprietorships are common because
setup is very easy. If you’re operating an unincorporated business and are the only owner, you are
What Is a Sole Proprietorship?
A sole proprietorship is an unincorporated business with one person or a married couple as the owner. Sole
proprietors report business income and losses on their personal tax return and are personally responsible
the business’s debts and legal obligations.
Although sole proprietorships are easy to start and to manage, they come with a host of legal, financial,
business risks. If someone sues your business, you have the most to lose as a sole proprietor. Sole
sometimes find it harder to get business loans and land big clients. Not to mention, corporations and
liability companies (LLCs) have certain tax advantages over sole proprietorships.
Learn everything you need to know to decide if a sole proprietorship is right for you, including tips on how
best run your business should you decide to join the ranks of the many sole proprietors.
Sole Proprietorship Definition
The best way to define sole proprietorship is an unincorporated business entity with one owner. Spouses can
jointly own and operate a sole proprietorship. More
than 70% of small businesses are organized as sole proprietorships, making this by far the most common
of business entity.
Unlike corporations and limited liability companies (LLC), which are state-registered business entities, a
proprietorship doesn’t require you to file formation papers with the state. So if you’re running a business
your own and haven’t registered the business, you already have a sole proprietorship. That said, you
still have to obtain business licenses and permits to comply with local laws.
The main selling points of a sole proprietorship business are easy formation and the fact that the owner is
entitled to all profits. But on the flip side, sole proprietors are also personally responsible for all of
business’s losses, debts, and legal obligations. This can give rise to a whole host of concerns. Next, we’ll
through all of the pros and cons of a sole proprietorship to help you decide if this business structure is
Sole Proprietorship Examples
Given how common they are, sole proprietorship examples are everywhere you look.
Sole proprietorship examples include:
- Virtual assistants
- Home-based business owners
Any time you open a business without any business partners, you have a sole proprietorship. The business
the moment you begin offering goods or services for sale. You can elect to incorporate your
business or register as an LLC, but in the absence of filing papers with the state, you have a sole
proprietorship on your hands.
Top 5 Advantages of Sole Proprietorships
A sole proprietorship is the simplest way to start and run a business, and there’s a lot to be said for
Small business owners are very busy people, with the majority devoting more than
50 hours per week to their business. If that describes you, then a sole proprietorship can be very
Here are the biggest advantages of sole proprietorships:
1. Initial setup is fast.
Wondering how to become a sole proprietor? Well, starting up a sole proprietorship is very easy. As we’ve
mentioned, there’s no need to register or incorporate your business with the state. All you have to do is
business permits and licenses (e.g. zoning permits, sales tax permits, liquor permits, etc.) that your state
local government require. You’ll also have to file a fictitious
business name (DBA) form with the state or locality if you’ll be operating the company under a trade
After that, you’re legally authorized to do business—that was easy!
Once you’re legally up and running, all you really need is a business checking account, a website, and some
customers to get going.
2. There are few ongoing legal requirements.
After you’ve set up shop, things remain pretty easy for a sole proprietorship from a paperwork standpoint.
why you’ll find freelancers, consultants, and other busy professionals often decide to organize their
as sole proprietorships—at least in the beginning. Sole proprietors don’t have to keep a bunch of
maintain their business’s legal status. In contrast, owners of corporations and LLCs have to keep meeting
bylaws, resolutions, and other documents.
3. Management is easy.
As a sole proprietor, you have complete control over business decisions and priorities. Conflicts among
is one of the leading causes of business failure, but fortunately, sole proprietors don’t
have to worry about this. You can change priorities, shift goals, and adjust your schedule however you
course, you have to keep employees in mind if you have staff).
Another benefit of a sole proprietorship is that your personal financial and legal situation and your
financial and legal situation are exactly the same. This can remove some of the headache associated with
track of your personal and business interests.
4. Sole proprietorship taxes are simple.
Filing taxes as a sole proprietor is also relatively straightforward. Sole proprietorships are considered
entities for tax purposes. This means that the owner reports business income and losses on the personal
return. You simply need to attach a Schedule C to your 1040 tax return. Since you’re the sole owner, there’s
need to figure out different ownership percentages and shares. You take home all of the
Many sole proprietors operate out of their homes. If that’s the case with your sole proprietorship, don’t
home business expenses
and car expenses (if you drive your personally owned car for business purposes).
5. Many sole props can take advantage of a 20% income tax deduction.
The recent tax reform law—the Tax Cuts and Jobs Act of 2017 (TCJA), aka the
Trump tax plan
— went into
effect earlier this year. The law will have some impact on virtually every small business’s tax burden. One
main provisions in the law is the Section 199A 20% tax deduction. This provision allows owners of
entities such as sole proprietorships to deduct 20% of the business’s net income from their taxes. The 20%
deduction can result in a big tax cut for many sole proprietors, though there are limits we describe below.
Top 5 Disadvantages of Sole Proprietorships
With just one person at the helm, a sole proprietorship is easy to set up and manage. However, that also
the business and your personal assets more vulnerable. Knowing the risks in advance can help you plan and
steps to protect yourself.
Here are the main disadvantages of sole proprietorships:
1. You face unlimited personal liability for business debts and lawsuits.
There’s no clear distinction between a sole proprietor and their business. Imagine two overlapping circles,
representing you (the owner) and the other representing the business. There are steps you can take to
yourself from the business, but financially and legally, there will always be some degree of overlap.
Sole proprietors are fully, personally liable for the business’s debts and obligations. That means creditors
legal claimants can go after your personal assets (e.g. your car, your personal bank accounts, your home in
cases) to get their money.
This can be very risky, particularly in industries where injuries are more common. For example, say you have
landscaping company and mow customers’ lawns. If someone trips on your lawn mower and injures themselves,
could very well sue your business for their medical costs. Since you’re a sole proprietor, the court could
successful claimant to go after your personal assets to get their money. Had you started an LLC or
only your business assets would be on the line.
2. Sole proprietorship taxes are higher.
As we mentioned above, recent tax reforms let pass-through entities like sole proprietorships take a 20% tax
deduction. This is a great way to lower your tax bill, but sole proprietors still usually end up paying more
than corporations and LLCs.
One reason is not all sole proprietors can utilize the 20% tax deduction. There are three main limitations:
- Amount of income:If you’re a sole proprietor and make over $315,000 (married
joint filers) or $157,500 (single filers) in annual business income, you can’t take the full deduction.
deduction phases down as your income increases.
- Business’s employees/assets:After reaching those income thresholds, you can
only take a phased-down version of the deduction if you have employees or depreciable business
If you don’t have employees or depreciable business property, you’re out of luck.
- Industry:Sole proprietors who provide certain types of services, including
actors, artists, athletes, lawyers, and accountants, also can’t take the full deduction after reaching a
On top of these limitations to the 20% tax deduction, sole proprietors often end up paying more
taxes (Medicare and Social Security tax). All sole proprietors must pay income taxes and self-employment
on the total income of the business. If your business is making a lot of money, that can be a big bill to
business owners have to pay self employment taxes, but owners of corporations can reduce their
burden by taking some money out of the business as dividends. Those dividends aren’t subject to
The tax code is very complicated, so we recommend consulting a tax professional to learn more about how
business structures will affect your tax bill.
3. Burnout is more likely.
Sole proprietors wear many different hats when running a business. Of course, you can hire employees or
independent contractors to help, but the reality is that many sole proprietorships don’t have extra hands to
Sole proprietors have to take care of marketing, advertising, finances, strategy, and leadership—and
else that comes with running a business. Doing too much on your own can lead to serious burnout and cause
business to fail.
4. Succession plans might be unclear.
Another problem with sole proprietorships is that the business might not survive the owner. Sole props often
build up a ton of intangible value and customer loyalty from the owner. That is great for a time, but can
business’s prospects if the owner passes away, experiences a disability, or retire. So, if you want your
to outlast you, consider incorporating or starting an LLC.
5. Landing clients is harder.
Customers and vendors are more likely to take you seriously when you structure your business as a
LLC. You might find the choice of business entity is important when trying to land a big client or buy raw
materials from a major supplier.
Raising Money for a Sole Proprietorship
Now that you know some of the pros and cons of sole proprietorships, there’s a broader point worth
matter what type of business structure you decide on, at some point you will need business financing to
Having a sole proprietorship works well if you plan to invest your personal finances—or family finances—into
business and grow the company from the ground up. However, a sole prop is more challenging if you want to
money from investors or take out a business loan.
To raise money from venture capitalists or angel investors, you must have a
corporation or LLC
Investors seek ownership (equity) in your business in exchange for funding, and you can’t carve up equity
own 100% of the business.
Sole proprietorships also face potential roadblocks when applying for business loans. Although sole
technically have almost all of the same funding options open to them, some lenders, particularly banks,
working with incorporated businesses because they statistically have a higher likelihood of success than sole
Registered businesses tend to survive for a longer time, so the owners are more likely to be able to repay the
In addition, some lenders are wary of sole proprietorships because of the legal risks. If someone
sues a sole proprietorship, the business and the owner are much more likely to go bankrupt, since your
inextricable. A corporation or LLC can weather more storms, leaving the business standing to pay back debt.
Increasing Your Odds of Business Loan Approval as a Sole Proprietor
Ultimately, lenders care more about a business owner’s credit and finances than about the business’s legal
structure. If you have a good credit score and positive cash flow, those factors work in your favor, and
are likely to approve your application, sole proprietorship or not. Your business entity status is likely to
a difference only in borderline cases.
Work on getting your credit score as high as possible and improving your business’s finances. In the
you have difficulty qualifying for a business loan, there are a few alternatives that are
great for sole proprietors:
- Personal loan for business:Sole proprietors can obtain a personal loan based on their personal credit
history and income. You can use a personal loan for eligible business purposes, but the loan amounts
aren’t very high.
- Business grants:Federal, state, and local government agencies and nonprofits
provide grants to small businesses.
- Business credit cards:Sole proprietors and freelancers can qualify for
business credit cards to use for business expenses.
If you organize your company as a corporation or LLC, then traditional business loan options, such as bank
SBA loans, and online term loans, might become easier to obtain.
Personal Guarantees Are Required for All Types of Businesses
No matter what type of business you have, keep in mind that almost all lenders will ask you to sign a personal
guarantee on a
business loan. A personal guarantee is a promise to pay back the loan, backed by your personal assets.
If you default on a loan, lenders will first look to your business assets to collect on the debt. But if the
business assets aren’t enough to cover the debt, then the lender can seize your personal assets. These might
include your car, personal bank accounts, and even your home, in some cases.
So, even if you aren’t a sole proprietor, you do have to personally guarantee a business loan, making your
personal assets fair game for creditors.
5 Ways to Lower Liability Risks of a Sole Proprietorship
After weighing the pros and cons, you might be drawn to the simplicity of sole proprietorships and decide
this business form is the right choice for you. Here are a few ways to take advantage of everything that a
proprietorship has to offer and minimize the disadvantages.
1. Open a business bank account.
Sole proprietors can establish some separation between themselves and the business by opening a business bank
The key to remember: Only use this account for business deposits and withdrawals. Maintaining a
business bank account will enable you to easily identify streams of business income and losses for tax
There are plenty of business bank accounts that require low minimum balances and allow you to make dozens of
deposits and withdrawals for free each month.
2. Get a business credit card.
A business credit card is another great tool for separating business expenses. Again, the key here is to use the
business expenses, nothing personal. Business credit cards are a great alternative to loans because specific
offer different credit limits, rewards points on purchases, and introductory 0% interest rates. And you can
the one that’s most advantageous to your business as a sole prop. While the introductory rate is in effect,
can basically borrow money interest-free.
3. Apply for an Employer Identification Number (EIN).
An employer identification number (EIN) is a unique, nine-digit number for your business.
Similar to a social security number for individuals, this number “follows” your business around on tax
credit reports, and loan applications.
Doesa sole proprietor need an EIN?
As a sole proprietor, you aren’t legally required to have an EIN, unless you have employees. Instead of an
you can use your personal social security number on business paperwork. That said, getting an EIN can help
build business credit. Having credit in your business’s name, as opposed to relying on your personal credit
can strengthen your business loan applications.
Depending on which state you’re located in, you might also need to get a state tax identification number.
Applying for a federal EIN is free and takes just minutes on the IRS’s website.
4. Purchase business insurance.
Sole proprietors face more legal risks compared to corporations and LLCs, but buying business insurance can
significantly lower your risk. There are several types of business insurance that you can purchase.General
insurance covers the cost of damage to your
business’s premises, equipment, or products. Product insurance covers damage ensuing from defective
home-based business insurance is available for sole proprietors who work out of their homes.
5. Draft clear contracts with your clients.
Contractual disputes between businesses or between employees and employers are common. Lawsuits can be very
debilitating for any company but especially for sole proprietors because your personal assets are completely
the line. One of the best ways to guard yourself is by drafting clear contracts whenever you do do business
supplier, vendor, or other third party.
Same goes when you hire employees or independent contractors. You can hire an attorney to create these
or write up simple contracts yourself.
Consider Starting as a Sole Proprietorship and Switching Later
One thing to keep in mind when deciding your business’s structure is that your initial choice of entity
in stone. Many freelancers and other business owners start out as sole proprietors and then later “graduate”
LLC or corporation when they reach one of these milestones:
- Going from a side gig to a full-time professional business
Hiring employees or multiple contractors (You can have employees as a sole proprietorship, but if you are
adding employees to your business, it might be better to restructure as an LLC)
- Significantly increasing revenue
- Working with major clients who prefer a registered business
Feeling a strong commitment to your business, as opposed to the business being a side gig or an experiment,
good signal that you might benefit from registering your business.
Switching to a different business structure is relatively straightforward and involves filing a few forms
the state. When you do so, you’ll need to check to see if the name you’d like to incorporate your business
a available. If so, you’ll need to file your articles of incorporation with the state office where you
After that’s filed, you’ll need to create an LLC operating agreement
outlining your business’s structure. And finally, you’ll have to obtain your employment identification
(EIN) from the IRS. You can ask a business attorney for help with this process or use a legal do-it-yourself
like LegalZoom or IncFile.
Sole Proprietorship vs. LLC
LLC is another popular business structure among small business owners.
There are several differences between sole proprietorships and LLCs:
- Formation – In order to form an LLC, you have to file formation papers, called articles of
organization, with the state. A sole proprietorship, on the other hand, is the default form of
a single-owner company.
- Taxes – LLC owners can choose whether to be taxed as a disregarded
entity or as a corporation. A sole proprietor must report business income and losses on a Schedule C
attached to their personal tax return.
- Liability – Members of an LLC are shielded from personal liability for business debts and
obligations. Sole proprietors face personal liability for any lawsuits or debts of the business.
Other than these core differences, it’s costlier and more time consuming to maintain an LLC compared to a
proprietorship. For instance, most states require LLCs to file an annual report and pay an annual tax. That
many business owners opt for an LLC to get limited liability protection.
Sole Proprietorship vs. Corporation
There are also several differences between sole proprietorships and corporations:
- Formation – To form a corporation, you must file articles of
incorporation with the state. Sole proprietorships don’t require a business filing for initial setup.
- Taxes – C-corporations and S-corporations have different tax rules.
>C-corps are subject to a
flat 21% corporate income tax. In an S-corp, business income and losses pass through to
shareholders’ personal tax returns.
- Liability – Shareholders in a corporation are shielded from personal liability for
debts and obligations. Sole proprietors, as mentioned above, can be sued personally by business creditors.
A corporation is the most complex type of business entity, with three layers of ownership and management:
shareholders, officers, and directors. There are several corporate formalities that you need to follow, such
holding shareholder meetings, to keep your corporation in good standing. For this reason, many small businesses
opt for an LLC, partnership, or sole
Sole Proprietorships Are Simple, but Face More Risk
Ultimately, a sole proprietorship offers the value of simplicity, but there are many potential downsides.
them, higher taxes, more legal exposure, and more difficulty landing new business.
Here are some considerations for sole proprietorships:
Sole proprietorships blur the distinction between business and owner.
Sole proprietors are personally liable for the debts and liabilities of the
business, which can be risky and in some cases cause your business to fail.
Thanks to recent tax reforms, sole proprietors take a 20% tax deduction on their
business income, but this is subject to some limitations.
Sole proprietors often pay more self-employment taxes.
There’s some data to indicate that sole proprietors have a tougher time landing a
business loan, but ultimately, lenders care most about your credit, cash flow, and finances.
If you decide to be a sole proprietor, take steps to limit your legal exposure by
separating business from personal finances as much as possible.
The main thing to keep in mind is that as your business evolves, so can your business structure. Be open to
changing your business entity to an LLC or corporation as you make more money, earn more clients, and
Sole Proprietorship Pros and Cons
is the simplest business entity, with one person as the sole owner and operator of the business. If you
new business and are the only owner, you are automatically a sole proprietorship under the law. There’s no
register a sole proprietorship with the state, though you might need local business permits or
licenses depending on your industry.
Freelancers, consultants, and other service professionals commonly work as sole proprietors, but it’s also a
viable option for more established businesses, such as retail stores, with one person at the helm.
Pros of Sole Proprietorship
- Easy to start up (no need to register your business with the state).
- No corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc.
- You can deduct most business losses on your personal tax return.
Tax filing is easy—simply fill out and attach Schedule C-Profit or Loss From
Business to your personal income tax return.
Cons of Sole Proprietorship
As the only owner, you’re personally liable for all of the business’s debts and liabilities—someone who
lawsuit against your business can take your personal assets (your car, personal bank accounts, even your
There’s no real separation between you and the business, so it’s more difficult to get a business loan and
raise money (lenders and investors prefer LLCs or corps).
- It’s harder to build business credit without a registered business entity.
Sole proprietorships are by far the most popular type of business structure in the U.S. because of how easy they are to set up.
There’s a lot of overlap between your personal and business finances, which makes it easy to launch and file
taxes. The problem is that this same lack of separation can also land you in legal trouble. If a customer,
employee, or other third party successfully sues your business, they can take your personal assets. Due to
risk, most sole proprietors eventually convert their business to an LLC or corporation.
General Partnership (GP) Pros and Cons
Partnerships share a lot of similarities with sole proprietorships—the key difference is that the business
two or more owners. There are two kinds of partnerships: general partnerships (GPs) and limited partnerships
(LPs). In a general partnership, all partners actively manage the business and share in the profits and
Like a sole proprietorship, a general partnership is the default mode of ownership for
multiple-owner businesses—there’s no need to register a general partnership with the state.
Pros of General Partnership
- Easy to start up (no need to register your business with the state).
- No corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc.
You don’t need to absorb all the business losses on your own because the partners divide the profits and
- Owners can deduct most business losses on their personal tax returns.
Cons of General Partnership
- Each owner is personally liable for the business’s debts and other liabilities.
In some states, each partner may be personally liable for another partner’s negligent actions or behavior
(this is called joint and several liability).
Disputes among partners can unravel the business (though drafting a solid partnership
agreement can help you avoid this).
It’s more difficult to get a business loan, land a big client, and build business credit without a
Most people form partnerships to lower the risk of starting a business. Instead of going all in on your own,
having multiple people sharing the struggles and successes can be very helpful, especially in the early
That being said, if you do go this route, it’s very important to choose the right partner or partners.
can seriously limit a business’s growth, and many state laws hold each partner fully responsible for the
of the others. For example, if one partner enters into a contract and then violates one of the terms, the
the other side can personally sue any or all of the partners.
Limited Partnership (LP) Pros and Cons
Unlike a general partnership, a limited partnership is a registered business entity. To
form an LP, you must file paperwork with the state. In an LP, there are two kinds of partners: those who
operate, and assume liability for the business (general partners), and those who act only as investors
partners, sometimes called “silent partners”).
Limited partners don’t have control over business operations and have fewer liabilities. They typically act
investors in the business and also pay fewer taxes because they have a more tangential role in the company.
Pros of Limited Partnership
An LP is a good option for raising money because investors can serve as limited partners without personal
General partners get the money they need to operate but maintain authority over business operations.
- Limited partners can leave anytime without dissolving the business partnership.
Cons of Limited Partnership
- General partners are personally responsible for the business’s debts and liabilities.
- More expensive to create than a general partnership and requires a state filing.
A limited partner may also face personal liability if they inadvertently take too active a role in the
Multi-owner businesses that want to raise money from investors often do well as LPs because investors can
You might come across yet another business entity structure called a limited liability
partnership (LLP). In an LLP, none of the partners have personal liability for the business, but most
only allow law firms, accounting firms, doctor’s offices, and other professional service firms to organize
LLPs. These types of businesses can organize as an LLP to avoid each partner from having liability for the
actions. For example, if one doctor in a medical practice commits malpractice, having an LLP lets the other
doctors avoid liability.
C-Corporation Pros and Cons
A C-corporation is
independent legal entity that exists separately from the company’s owners. Shareholders (the owners), a
directors, and officers have control over the corporation, though one person in a C-corp can fulfill all of
roles, so it’s possible to create a corporation with you in charge of everything.
With this type of business entity, there are many more regulations and tax laws that the company must comply
with. Methods for incorporating, fees, and required forms vary by state.
Pros of C-corporation
- Owners (shareholders) don’t have personal liability for the business’s debts and liabilities.
C-corporations are eligible for >more
tax deductions than any other type of business.
- C-corporation owners pay lower self-employment taxes.
- You have the ability to offer stock options, which can help you raise money in the future.
Cons of C-corporation
More expensive to create than sole proprietorships and partnerships (filing fees range from $100 to $500
on which state you’re in).
C-corporations face double taxation: The company pays taxes on the corporate tax return, and then
pay taxes on dividends on their personal tax returns.
- Owners cannot deduct business losses on their personal tax return.
There are a lot of formalities that corporations have to meet, such as holding board meetings and
meetings, keeping meeting minutes, and creating bylaws.
Most small businesses pass over C-corps when deciding how to structure their business, but they can be a
choice as your business grows and you find yourself needing more legal protections. The biggest benefit of a
C-corp is limited liability. If someone sues the business, they are limited to taking business assets to
judgment—they can’t come after your home, car, or other personal assets.
Corporations are a mixed bag from a tax perspective—there are more tax deductions and fewer self-employment
taxes, but there’s the possibility of double taxation if you plan to offer dividends. Owners who invest
back into the business as opposed to taking dividends are more likely to benefit under a corporate
S-Corporation Pros and Cons
preserves the limited liability that comes with a C-corporation but is a pass-through entity for tax
This means that, similar to a sole prop or partnership, an S-corp’s profits and losses pass through to the
personal tax returns. There’s no corporate-level taxation for an S-corp.
Pros of S-corporation
- Owners (shareholders) don’t have personal liability for the business’s debts and liabilities.
No corporate taxation and no double taxation: An S-corp is a pass-through entity, so the government taxes it much like a sole
proprietorship or partnership.
Cons of S-corporation
Like C-corporations, S-corporations are more expensive to create than both sole proprietorships and
partnerships (requires registration with the state).
There are more limits on issuing stock in S-corps vs. C-corps.
You still need to comply with corporate formalities, like creating bylaws and holding board and
In order to organize as an S-corporation or convert your business to an S-corporation, you have to file IRS form
S-corporations can be a good choice for businesses that want a corporate structure but like the tax
a sole proprietorship or partnership.
Limited Liability Company (LLC)
A limited liability
company takes positive features from each of the other business entity types. Like corporations, LLCs
limited liability protections. But they have few paperwork and ongoing requirements, and in that sense, they
more like sole proprietorships and partnerships.
Another big benefit is that you can choose how you want the IRS to tax your LLC. You can elect to have the
treat you as a corporation or as a pass-through entity on your taxes.
Pros of LLC
- Owners don’t have personal liability for the business’s debts or liabilities.
- You can choose whether you want your LLC to be taxed as a partnership or as a corporation.
- Not as many corporate formalities compared to an S-corp or C-corp.
Cons of LLC
It’s more expensive to create an LLC than a sole proprietorship or partnership (requires registration with
LLCs are popular among small business owners, including freelancers, because
they combine the best of many worlds: the ease of a sole proprietorship or partnership with the legal
of a corporation.
Business Entity Types: How to Choose the Best One for Your Business
With a better understanding of how the common business entity types work and their respective pros and cons,
can now determine which of the different types of business entities works best for your small business. The
course of action, if you can afford it, is to consult a business lawyer and
tax professional on which structure is optimal for you, given where your business is currently and where you
to take it.
As a starting point, though, there are three general factors to consider when choosing among business entity
types: legal protection, tax treatment, and paperwork requirements. In the table below, see how the entities
up on each of these factors.
Sole props and GPs are light on liability protections, so they expose you to greater legal risk if someone
your business. But taxation is simple when you have a sole prop or GP, and you don’t have nearly as many
government requirements to comply with. That means more time to do what you love—running your business.
The simplicity of a sole prop or a partnership makes it a good starting point for freelancers and
particularly if the industry you’re in brings little legal risk with it.
If your business is in a more litigious industry, such as food service, child care, or professional
that’s a strong reason to create an LLC or corporation right off the bat. And regardless of industry, as
business grows and more dollars are at stake, that can be the ideal time to “graduate” to an LLC or
What works for a freelancer or hobbyist likely won’t work for someone who is trying to hire employees, bring
additional owners, or expand.
Although it’s certainly possible to change business structures at any point of your business’s journey, some
changes are easier to make than others. For instance, it’s relatively simple to convert from a sole prop or
partnership to an LLC by filing the right paperwork with your state. But converting to a corp is more
particularly if you plan to issue stock. Converting from a C-corp to an
S-corp can bring unexpected taxes. So, before changing your business structure, make sure you’ve thought
through and spoken to a lawyer.
Also keep in mind that the IRS places certain limits and deadlines on how often you can change your
Tax Reforms Will Impact All Types of Business Entities
The Tax Cuts and Jobs Act—which you might know as the Trump Tax Plan—took
effect this year and impacts some of the tax considerations around your business entity choice.
Congress made two main changes that impact small businesses:
C-corporations are subject to a flat 21% corporate tax rate, a significant cut from the previous
corporate tax rate.
Owners of pass-through entities can deduct 20% of business income on their personal income tax
returns. These include owners of sole proprietorships, S-corps, LLCs that have elected pass-through tax
and general partners in a partnership. There are some limitations on the deduction based on business type
Right after Congress passed this law, many business owners began wondering if they should convert their
businesses to C-corporations to enjoy the new flat tax rate. The 21% flat tax rate may be lower than your
tax rate, but you also lose the 20% deduction if you convert your company to a C-corp.
The main situation where it might make sense to convert to a C-corp is if you are ineligible for the 20%
pass-through deduction. Under the new law, businesses with income over $315,000 (married joint filers) or
(single filers) can’t take the full pass-through deduction. The deduction slowly phases out at that time,
most restrictions being on professional service firms like doctors and lawyers.
Apart from the new tax reform, the other potential pitfall with a C-corporation is double taxation. If you
planning to take distributions from your business, then you’ll pay the 21% corporate tax rate plus personal
on the distributions. A C-corp makes more sense when a business is in total growth mode and the owners
all the profits back into the company (instead of taking distributions).
What You Should Know When Choosing Among the Types of Business Entities
Your choice of business entity is a very important one. It can affect how people perceive your business and
big impact on your legal exposure and finances.
Keep the following in mind when deciding among the different types of business entities:
- Sole props and general partnerships are good “starter” entities.
- As your business grows and generates more income, consider registering as an LLC or corp.
Think through the pros and cons of each business entity in terms of legal protection, tax treatment, and
- Consult a business lawyer and accountant to get specific help for your business.
There’s no one best business entity choice for all small businesses, but there is a best option for your
business right now. Use the tips above to figure out what that is.
Schedule C Instructions: Easy Step-by-Step Help
If your business is a sole proprietorship, or if you’re self employed, you must complete a Schedule C tax
form each year as part of your tax filing process. The IRS Schedule C is used to determine the taxable
profit in your business during the tax year. You then report this profit on your personal 1040 Form and
calculate the taxes due from there.
Although the Schedule C form is one of the easier tax forms to understand and complete, you might find
completing it for the first time a little daunting. Even if you use the services of a tax professional, you
still need to understand how to complete Schedule C to ensure the accuracy of your tax filing
The IRS provides detailed, line-by-line instructions for completing the Schedule C tax form, so we won’t
duplicate that here. But that’s not always the most helpful for everyone, so what we’ve outlined here is a
step-by-step walkthrough of Schedule C instructions, written in plain English.
Schedule C Instructions: 5 Things You’ll Need to Complete Your Form
A quick glance:
- The IRS’s instructions for Schedule C.
- Your employer ID number (EIN).
- Profit and loss statement for the tax year.
- Inventory count and valuation as of the end of the tax year.
- Mileage records.
The first step in your Schedule C instructions is to compile some information. This includes:
1. The IRS’s instructions for Schedule C. Even if the rest of the IRS Schedule C form looks
straightforward enough that you don’t think you’ll need instructions, you’re still going to need the
Principal Business or Professional Activity code for your business. This is conveniently located within the
2. Your employer identification number (EIN). If you have a separate EIN for your business, you must
include it on your Schedule C. If you haven’t memorized your EIN, you can find it on your Form SS-4
3. Profit and loss statement for the tax year. Schedule C is a reporting of the profit or
loss in your business. You can find most of the information you need to complete your Schedule C tax form on
the income statement from your bookkeeping software. Make sure
you’re using the correct basis (most small businesses file their tax returns on a cash basis.)
4. Inventory count and valuation as of the end of the tax year. If you sell items in your
business, you need to determine the cost of the goods you sold during the tax year. Conduct an annual
physical inventory in your business to validate the information in your point of sale or other inventory
management software before completing your IRS Schedule C.
5. Mileage records. If you use your personal vehicle for your business, you must keep
mileage records to deduct the expenses for the business use of your vehicle. Avoid the temptation to
“estimate” your mileage. There are a number of good smartphone apps you can use to track
your mileage, or you can keep a paper mileage log.
6-Part IRS Schedule C Instructions
If you have the information above complied, completed, and ready, then you’re set to move on to completing
the your Schedule C tax form. You can find a fillable PDF of the form on the IRS’s website or you
can use tax preparation software to complete your IRS Schedule C. Whichever approach you choose, your
Schedule C form will look the same—and all of these steps apply.
Schedule C Tax Form Header
The top part of IRS Schedule C doesn’t have a section header or a name, but it is still important.
Following these Schedule C instructions, the top part of the form is where you’ll enter:
- Your name: Your name will be entered in the “Name of proprietor” field.
- Your social security number: Since the profit on Line 31 carries over to your Form 1040, you
must enter your SSN on Schedule C, even if you also have an EIN.
- Lines A and B: These fields identify your type of business or business activity.
You only need to include a very brief description on Line A, and the code needed for Line B is included in
the IRS’s instructions for Schedule C.
- Lines C, D, and E: Enter your business’s name, EIN, and address.
- Line F: Identify your tax accounting method. Most small businesses use the cash
accounting method. Once you choose your tax accounting method, you must continue using the same method
unless you file Form 3115 to change it.
- Line G: A quick rule of thumb is if you work in your business, you materially
participate in it and need to check the Yes box on this line. If you aren’t sure if you
materially participate in your business, consult with an accountant.
- Line H: You’ll only check this on the very first IRS Schedule C you
complete for your business. This line lets the IRS know this is your first year in business.
- Lines I and J: If you paid subcontractors for work they did in your business, or
if you paid individuals for other services, you may need to file Form 1099 for the payments you made to
them if you paid them at least $600 during the tax year. If you check Yes on Line I, then
you also need to check Yes on Line J… and file the Form(s) 1099 required.
Schedule C Form Part I: Income
The Schedule C instructions for Part I is to report the income in your business. It’s also where you
calculate your gross profit and your gross income.
- Lines 1, 2, and 3: Report your total income, before deductions for returns and refunds, on Line
1. This amount does not include any sales taxes
you collected. Any refunds you gave to your customers are reported on Line 2, and then Line 3 is the
difference between your total income and any refunds given to customers.
- Lines 4 and 5: If you sell products or have non-employee labor costs, skip these
lines for now and come back to them after you’ve calculated your cost of goods
sold in Part III. If you don’t sell products or have subcontracted labor costs, enter a “0” on Line
4 and enter the Line 3 total on Line 5.
- Line 6: Report any income that does not come from your normal business operations. This
is often listed as “Other Income” on your P&L statement.
- Line 7 is the sum of Lines 5 and 6. This is your gross income.
Schedule C Form Part II: Expenses
Your business expenses reduce the profit in your business, and—with regard to taxes—less profit is
desirable because it means a lower tax liability. This does not mean you should incur unnecessary
expenses just to avoid paying taxes. You ultimately want a profitable business, but, as you follow these
Schedule C instructions, be sure you are capturing all your qualified business expenses on your IRS Schedule
C tax form.
Most of the fields in Part II are self-explanatory, and you can pull the numbers you need from your Profit
and Loss statement. Most business owners will have expense categories on their P&L that don’t directly
tie to any one of Lines 8 – 27a. You can use Part V of Schedule C to capture these expenses.
There are a few lines in Part II that require more in-depth explanation, though:
- Line 9: If you use your personal vehicle in your business, you have a choice to either use the
actual expenses for business use of your vehicle or take a mileage deduction. Most taxpayers find it
advantageous to take the mileage deduction. Whichever method you choose, you must complete Part IV of
Schedule C and have written evidence or receipts to support the deduction.
- Line 11: This is used to report contract labor. This does not include wages you pay to
employees (Line 26) or the cost
of labor reported as cost of goods on Line 37.
- Line 13: If you purchase buildings, equipment, furniture, or other fixed assets in
your business, you typically cannot deduct the full cost of the purchase in one year. Instead, you must
depreciate the asset over a number of years and only report that year’s depreciation deduction on Line 13.
- Line 18: This is used only for office supplies and postage. Other office expenses can
be listed in Part V. The total from Line 48 in Part V is reported on Line 27a.
- Line 24b: In most cases, you can only deduct 50% of the meals and entertainment
expenses for your business. The meals or entertainment must have a specific business purpose. You must
keep documentation of the business nature of the expense, as well as the name of the client or potential
client you entertained, to support your meals and entertainment expenses. More information on what is—and
is not—deductible is included in the IRS’s instructions for Schedule C, referenced above.
- Line 28 is the sum of all your expenses on Lines 8 through 27a. This amount should be
very close to the total expenses on your profit and loss statement, with an allowance made for the 50% of
your meals and entertainment expenses which is not tax deductible.
- Line 30: If you have a home office, you can deduct a portion of your household expenses on
30. To do this, you can either complete Form 8829 or use the simplified method right on Schedule C. The
IRS has very specific rules about what constitutes as a home office, so read pages C-9 through C-13 of the
Schedule C instructions carefully.
- Line 31: After you’ve completed all parts of Schedule C and double checked your
entries, you’re ready to calculate your net profit or loss. Most
taxpayers will report the amount on this line—whether positive or negative—on Form 1040, Line 12. Certain
exceptions apply if your income comes from estates or trusts, or if not all your investment is at risk.
Talk to an accountant or a tax professional if this applies to you.
Schedule C Form Part III: Cost of Goods Sold
Hang in there… we’re almost done! You’ll use Part III of the Schedule C tax form if you sell products or
use subcontractors to generate income in your business.
Most of the lines in Part III are straightforward. You can pull the amounts required directly from your P&L
or point of sale system, or make a simple calculation to arrive at the necessary subtotals. When following
these Schedule C instructions, make sure you don’t include any expenses included in Part II.
Line 33 warrants a little additional explanation. On this line, you will state your inventory
valuation method. Most small businesses use the “Cost” inventory valuation method, as it is the least
complicated. If you’re using the cash method of accounting—as most taxpayers do—then you must use
the cost method.
Schedule C Form Part IV: Information on Your Vehicle
If you’re claiming vehicle expenses on Line 9, you have to complete Part IV of
This is where you’ll use the mileage records mentioned earlier in this article. Again, don’t be tempted to
estimate or guess at this information. In the event of an audit, you’ll be required to provide evidence your
vehicle expense deduction is valid, so keep your mileage records in a
Schedule C Form Part V: Other Expenses
Part V is the section of Schedule C used to capture the expenses you didn’t report on Lines 8
through 26 or Line 30. Remember, you are allowed by law to deduct all legitimate
business expenses from your income to reduce your taxable profit. Don’t skip an expense just because it
doesn’t have a specific line number in Part II. List the expense in Part V, and the enter the total of all
lines in Part V on Line 27a.
Your IRS Schedule C Tax Form Is Now Complete!
Whew! If you’ve effectively followed these Schedule C instructions, your IRS Schedule C form should now be
Before you enter the profit or loss on Line 31 onto your Form 1040, take a few minutes to review your IRS
Schedule C and double check your calculations one more time. Or, if your accountant has prepared your tax
return for you, compare your IRS Schedule C with your P&L for the tax year. Your accountant will be
happy to answer any questions you have, so you can be sure you’re filing the most accurate tax return you