Still Operating as a Sole Proprietor? What's Actually at Risk

I worked with a plumber in Katy who operated as a sole proprietor for four years. Good business. $280,000 in revenue. Steady referral stream from builders in the Fort Bend County area.

He never got around to filing for an LLC. The paperwork felt unnecessary. The $300 filing fee felt like money that could go somewhere else.

Then a pipe burst in a commercial job. Water damage to the building’s server room. The property owner’s insurance company came after him for $165,000.

As a sole proprietor, his business and personal assets were the same legal entity. His personal checking account. His truck. His house. All of it was on the table.

Not because he was negligent. Because his business had no legal boundary between the company and the person behind it.

He settled for $80,000. Paid it from personal savings and a home equity line. Filed for an LLC the following week.

The $300 he’d been avoiding would have kept his personal assets completely separate from the claim.

What a Sole Proprietorship Actually Means in Texas

Every business that hasn’t filed formation documents with the Texas Secretary of State is a sole proprietorship by default. There’s no form. No registration. No conscious decision.

If you’re doing business under your own name and haven’t incorporated, you’re a sole proprietor.

In Harris County alone, thousands of small businesses operate this way. Handymen. Consultants. Freelancers. Food truck operators. Cleaners. Tutors. Many of them don’t realize the legal implications until something goes wrong.

A sole proprietorship means:

Every business debt is your personal debt. If the business can’t pay a vendor, the vendor can pursue your personal assets.

Every lawsuit against the business is a lawsuit against you personally. There is no corporate shield.

If the business fails, creditors can come after your home, your car, your savings, your retirement accounts (with limited exceptions for IRAs and 401(k)s under federal law).

Your personal credit is your business credit. There is no separation.

Texas law provides no special protections for sole proprietors. The only way to create a legal boundary between a business and its owner is to form a separate legal entity.

The LLC: What Most Houston Businesses File

An LLC (Limited Liability Company) is the most common business structure for Houston small businesses. For good reason. It provides liability protection without the administrative complexity of a corporation.

Filing an LLC in Texas requires:

Certificate of Formation filed with the Texas Secretary of State. The filing fee is $300. Processing takes 2 to 5 business days online.

Registered agent designation. Every Texas LLC must have a registered agent with a physical address in Texas (not a P.O. box) who can receive legal documents on behalf of the business. This can be the business owner. Many choose a registered agent service ($50 to $150/year) to avoid having their home address on public filings.

EIN (Employer Identification Number) from the IRS. Free. Takes 10 minutes online. Required for opening a business bank account, hiring employees, and filing business tax returns.

Operating agreement. Texas doesn’t require this to be filed with the state. But every LLC should have one. It defines ownership percentages, profit distribution, management structure, and what happens if an owner leaves or the business dissolves. Without one, Texas default rules apply. Those defaults don’t always match what the owners intended.

Total cost to form a basic LLC in Texas: $300 to $450, depending on whether you use a registered agent service. A business attorney in Houston charges $500 to $1,500 to handle the formation and draft an operating agreement. For multi-member LLCs or businesses with complex ownership, the attorney is worth it.

Harris County Assumed Name Filing

If the LLC operates under a name different from its legal name (for example, if “JR Contracting LLC” does business as “JR Plumbing and Drain”), a DBA (Doing Business As) must be filed with the Harris County Clerk’s office. The filing fee is $27 for one assumed name. This is separate from the state LLC filing.

LLC vs. S-Corp vs. C-Corp: Which One and When

The LLC is the entity. The tax treatment is a separate decision.

A single-member LLC is taxed as a sole proprietorship by default. All profit flows to the owner’s personal return on Schedule C. It’s subject to self-employment tax at 15.3%.

At a certain income level, electing S-Corp taxation changes that equation significantly.

The Quick Math

I worked with a Montrose restaurant owner. Her LLC generates $300,000 in net profit. No S-Corp election. She pays self-employment tax on the full $300,000.

$300,000 x 15.3% = $45,900 in SE tax alone.

With an S-Corp election and a reasonable salary of $90,000, only the salary is subject to employment taxes.

$90,000 x 15.3% = $13,770 in employment taxes.

The remaining $210,000 flows through as a distribution. Not subject to SE tax.

Tax savings: $32,130 per year.

The S-Corp election isn’t free. It requires running payroll (cost: $500 to $2,000/year through a service like Gusto or ADP). Filing a separate S-Corp return (Form 1120-S). Maintaining reasonable compensation documentation.

But for businesses earning over $60,000 to $80,000 in net profit, the savings dwarf the compliance costs.

The full breakdown is in our S-Corp vs. LLC tax comparison.

When a C-Corp Makes Sense

C-Corps are rare for Houston small businesses. The double taxation problem (corporate income tax at the entity level, then personal income tax when dividends are distributed) makes them a poor fit for most service businesses.

The exceptions:

Businesses planning to raise venture capital. Investors prefer C-Corp structure.

Businesses qualifying for the QSBS (Qualified Small Business Stock) exclusion. This can eliminate capital gains tax on up to $10 million when selling C-Corp stock held for 5+ years. Our QSBS guide covers the details.

Businesses with significant retained earnings that want to reinvest at the corporate tax rate (21%) rather than the owner’s personal rate (which could be 32% to 37% for high earners).

For a typical Houston contractor, consultant, or service business, the LLC with S-Corp election is the right structure in 90%+ of cases.

The Texas Franchise Tax

Texas doesn’t have a state income tax. But it has the franchise tax. It functions as a business income tax under a different name.

The franchise tax applies to all legal entities (LLCs, corporations, partnerships) doing business in Texas. Sole proprietors are exempt. Which is one of the few structural advantages of not incorporating.

The current thresholds (2025):

Businesses with total revenue under $2.47 million are not required to pay franchise tax. They still must file a Public Information Report annually.

Businesses above $2.47 million pay either 0.375% (retail/wholesale) or 0.75% (all others) on taxable margin.

The no-tax-due threshold means most Houston small businesses owe zero franchise tax. But the filing requirement still exists. Missing it triggers penalties.

The annual franchise tax report is due May 15. Late filing carries a $50 penalty plus 5% of the tax due (even if the tax is $0). I’ve seen Houston business owners get penalized for not filing a report that would have shown they owe nothing.

The penalty is small. The annoyance is large.

What Happens If You Don’t Incorporate and Something Goes Wrong

The plumber in Katy learned this the hard way. But the scenarios extend well beyond lawsuits.

Unpaid vendors. A landscaping company orders $12,000 in materials from a Houston nursery. Business slows down. The invoice goes unpaid. As a sole proprietor, the nursery doesn’t sue the business. They sue the owner. The judgment can attach to personal bank accounts.

Employee injuries. Workers’ compensation in Texas is optional for private employers. A sole proprietor without workers’ comp who has an injured employee faces personal liability for medical costs and lost wages. The amounts can be catastrophic.

Tax debt. A business that falls behind on payroll taxes owes those taxes regardless of structure. But with an LLC, the business’s other assets can be separated from the owner’s personal assets during resolution. A sole proprietor has no such boundary.

Divorce. In Texas community property law, a sole proprietorship is a community asset. In a divorce, the business’s value (and its liabilities) are divided between spouses. An LLC with a properly drafted operating agreement provides clearer boundaries for valuation and division.

None of these scenarios are exotic. They happen to Houston businesses every month.

The difference between a business with legal structure and one without is whether the owner sleeps at night knowing their house isn’t collateral for a business problem.

The Filing Takes 30 Minutes

Forming a Texas LLC online through the Secretary of State’s SOSDirect portal takes less than 30 minutes. The $300 filing fee is paid by credit card. The certificate is typically issued within 2 to 5 business days.

After formation:

Apply for an EIN on the IRS website. Immediate issuance.

Open a business bank account at Frost, Chase, Comerica, or your preferred Houston bank. You’ll need the Certificate of Formation and EIN.

File an assumed name certificate with the Harris County Clerk if operating under a DBA.

Separate personal and business finances completely. This means separate bank accounts. Separate credit cards. No commingling. The liability protection an LLC provides disappears if a court finds that the owner treated the business as a personal piggy bank. A concept called “piercing the corporate veil.”

Draft an operating agreement. Even for a single-member LLC, this document clarifies management authority, capital contributions, and dissolution procedures.

The entire process, from filing through bank account opening, takes about two weeks. The $300 to $1,500 investment (depending on whether an attorney is involved) protects every personal asset the owner has.

The plumber in Katy paid $80,000 to learn this. The filing fee hasn’t changed.

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