Definition: A sole proprietor is a natural person who carries on a trade or a freelance activity independently and operates the business without partners. Legally, the sole proprietorship is not a separate legal entity; owner and business are not legally separate, which is why the proprietor is personally and with unlimited liability responsible for business obligations.
Fundamental Characteristics
As a sole proprietor you act on your own account. Key characteristics are personal liability, simple formation and direct profit determination. Crucial is whether you are classified as a freelancer (for tax purposes not subject to trade tax, no trade licence required) or as a trader (trade registration required, subject to trade tax).
Legal Form and Liability
Unlike a GmbH or UG, as a sole proprietor you are liable with your entire personal assets for business liabilities. This personal liability affects your insurance/financial protection, creditworthiness and contract arrangements.
Freelancer or Trader
For liberal professions (e.g., doctors, tax advisors, engineers) simplified tax rules apply. Traders must register their business and may be required to pay trade tax. The distinction has direct consequences for bookkeeping and tax obligations.
Accounting Obligations and Tax Treatment
For bookkeeping it is decisive whether you are obliged to use the simple income-expenditure accounting (Einnahmenüberschussrechnung, EÜR) or double-entry bookkeeping. Many sole proprietors prepare the EÜR under §4(3) of the German Income Tax Act (EStG). Commercial accounting obligations arise from the German Commercial Code (HGB) if you qualify as a merchant.
EÜR versus Balance Sheet Accounting
The EÜR is practical for many small businesses and freelancers: income and expenses are compared. Balance sheet accounting under the HGB is required if commercial merchant status exists or if tax- or turnover-related thresholds are exceeded. In practice turnover and profit expectations are often used as guideline figures; check the details with your tax advisor.
VAT, Income Tax, Trade Tax
As an entrepreneur you are subject to value-added tax (VAT) — depending on your turnover regime you must file advance VAT returns monthly, quarterly or annually. The profit is subject to income tax. Trade businesses must additionally pay trade tax; freelancers are exempt from this.
Practical Bookkeeping Tips
Concrete measures make your daily bookkeeping easier and minimize errors:
- Post transactions using standardized charts of accounts (e.g., SKR03 or SKR04).
- Separate private and business payments by using a dedicated business account.
- Document every transaction with complete supporting documents (invoice, receipt, contract).
- File VAT advance returns continuously and make tax payments on time.
- Regularly back up your accounting software and archive supporting documents.
Examples of typical journal entries:
| Transaction | Journal entry (simplified) |
|---|---|
| Invoice to customer (net €1,000 + 19% VAT) | Accounts receivable to Sales revenue €1,000; Output VAT €190 |
| Purchase of operating supplies (net €500 + 19% VAT) | Expense / Operating supplies to Accounts payable €500; Input VAT €95 |
| Owner withdrawal (cash withdrawal) | Owner's drawing to Cash / Bank |
Common Errors and Checklist for the Annual Accounts
Avoid the following frequent errors:
- Mixing private and business expenses.
- Missing or incomplete document filing.
- Irregular VAT advance returns with estimates without documentation.
- Not accounting for depreciation (AfA — tax depreciation) on investments.
Checklist for the annual accounts:
- Reconcile accounts (bank, cash, receivables, payables).
- Review depreciation and provisions.
- Document owner withdrawals and own contributions.
- Prepare the EÜR form (Anlage EÜR) or a balance sheet including a profit and loss statement.
- Observe tax deadlines: income tax, where applicable trade tax, VAT.
Conclusion: As a sole proprietor you benefit from simple formation and direct tax liability, but you bear full personal liability. Practical bookkeeping means consistently separating private and business transactions, regular documentation and timely filings to the tax office and, if applicable, to the trade office. In case of uncertainty, especially regarding balance sheet obligations or trade tax, consulting a tax advisor is recommended.