A sole proprietorship is an unincorporated business operated by one individual. For federal tax purposes, net income from a sole proprietorship is self-employment (SE) income. An individual taxpayer must report self-employment income on Schedule C (Profit or Loss From Business), and the net earnings are subject to self-employment taxes on Schedule SE (Self-Employment Tax).
What’s an Example?
John decides to open a lemonade stand in his neighborhood. John does not form a corporation to conduct his business.
John sets up his lemonade stand at the end of his driveway and starts selling cups of lemonade to neighbors. John’s total sales for Day 1 were $50, and his total expenses for cups, lemonade mix, and water were $35. John’s pretax profit is $15.
John’s business is characterized as a sole proprietorship because he operates it without a corporation and is the sole owner. In contrast, if John had formed a corporation and owned 100% of the stock, his business would no longer be a sole proprietorship because he was using a corporate entity.
A sole proprietorship can also exist with a single-member limited liability company (LLC). If John formed an LLC and he was the 100% owner, the entity is, by default, treated as a disregarded entity for U.S. federal tax purposes. A disregarded entity with an individual owner is a sole proprietorship. If John files an election to make the LLC an “S” corporation or a “C” corporation, it is no longer a disregarded entity or a sole proprietorship.
An LLC can file an S corporation election using Form 2553 (Election by Small Business Corporation) or a C corporation election using Form 8832 (Entity Classification Election).
Taxpayers can find more information about sole proprietorships here on the IRS website.