Sole proprietorships come with special tax burdens, such as having to estimate and pay quarterly taxes. The business entity also comes with special tax breaks, including such deductions as the pass-through entity qualified business income deduction.

“Add the self-employment tax as another tax burden, typically the tax that your employer would pay for their employee,” said Jon Ekoniak, managing partner at Bordeaux Wealth Advisors in Menlo Park, Calif.

Often a default entity—especially for clients starting their own business—a sole proprietorship has one owner and requires no business name, separate business bank account or paperwork to create. “[It's] the easiest and most affordable way to organize a business because there is no separate legal entity created and no other business owners to consider,” says the blog of accounting firm Drucker & Scaccetti in Philadelphia.

There are no other owners to shoulder the burdens of taxes, debt and estate planning, either. For example, without a designated successor, the business dies with the proprietor.

Though income is reported directly with the owner’s personal income tax return in the year it’s earned – with no additional paperwork – sole proprietors’ business income is subject to an additional 15.3% self-employment tax for contributions towards Medicare and Social Security, Drucker & Scaccetti notes. Sole proprietors and pass-through entities can deduct up to 20% of net business income from their taxes, with some restrictions on income and other factors.

“Most people understand their personal tax situation from the viewpoint of the employee. They often lack a deep understanding of the obligations and benefits of the employer,” Ekoniak said. “The sole proprietor is the HR, accounting and benefits department all wrapped into one, so it’s difficult to keep up on all of those responsibilities and run a business.”

Ekoniak noted areas where sole proprietors can leverage tax breaks. “We rarely see [them] taking full advantage of their retirement planning opportunities,” he said, adding that the Simplified Employee Pension (SEP) IRA has been “the go-to retirement plan for sole proprietors for many years due to the low start-up and maintenance costs and the ability to contribute 25% of income” up to a maximum of $61,000 for 2022.

Also often overlooked: the solo 401(k), similarly with low startup and maintenance costs but allowing contributions “as both an employee and an employer,” Ekoniak said. The total maximum contribution is the same as the SEP IRA, but “the employee can contribute up to 100% of their income with a maximum of $20,500 to their solo 401(k) as an employee ... and then approximately 25% of their income as the employer,” he said.

“When you get into higher levels of income for older employees, a defined-benefit plan may allow you to contribute even greater amounts, up to $245,000 for 2022,” Ekoniak said. “There are more reporting requirements and maintenance costs for a defined benefit plan, so it makes the most sense for those with higher income levels. One can also combine a defined benefit plan and a solo 401(k).”

These business operators do need to track and document deductible tax expenses precisely. “When one is working from home, work and personal lives tend to blend,” Ekoniak said. “It’s important to be very diligent in tracking exactly what’s used for the business.”

Sole proprietors are also personally liable for business debts—with even their personal assets on the line to satisfy claims against the business, unlike with a single-member limited liability company.

LLC entities have limited liability (like corporations), but they may be taxed as sole proprietorships if owned by one individual, according to the IRS, which adds that the number of sole proprietorship returns that indicated status as an LLC has jumped more than 16-fold in the past two decades.

“Make sure you’re protected from an insurance and liability standpoint,” Ekoniak said.