Choosing a Business Entity: Sole Proprietor

woman standing with arms crossed

You may be a sole proprietor and not even realize it. For example, freelance workers who are not employed by anyone but work and earn money for themselves are sole proprietors. It is the simplest type of business structure.

Advantages to being a sole proprietor

It is easy to establish: All you have to do is declare you are a sole proprietor and open your door for business. There are no documents that need to be filed with the state. However, you should check your state and local laws to see if you have to obtain a business license or if there are any requirements that you register your business. And if you have employees, you will need to get a tax identification number from the Internal Revenue Service (IRS) and learn how to withhold taxes from their earnings.

You are the one in control who makes all the decisions: You are accountable only to yourself, not to a board of directors or shareholders. You are the boss and can run your business any way you want.

There are some tax advantages also: You do not file a separate tax return for your business. You file your individual tax return where you list all the business income and deductions. You are taxed as though your business profits are personal income, not at the rates applied to corporations.

You can change the business structure: If your business changes, you are not locked in to being a sole proprietor forever if a different structure seems it would better meet your business needs.

Disadvantages to being a sole proprietor

Creditors can hold you personally liable for debts: This may be the biggest disadvantage to being a sole proprietor. You are held personally responsible for any debts incurred by your business. If you buy an expensive piece of equipment and a business setback keeps you from being able to pay for it the creditor can try to collect from your personal assets.

You are personally liable for legal judgments against the business: For example, if your employee has a car wreck while on company business, and an injured person sues and wins a judgment in court, the injured person may be able to collect from your personal assets including your bank accounts.

There are some tax disadvantages: In addition to tax benefits, there are disadvantages in that as a sole proprietor, you will need to pay self-employment taxes and make quarterly tax payment to IRS based on estimated taxes.

The business does not continue upon your death: If you die as a sole proprietor, the business will be liquidated and the assets and liabilities become part of your personal estate.

How to choose

There are two primary methods to protect your personal assets from the debts and liabilities of your business.

One is to organize the business as a limited liability company, corporation, or other limited liability entity. The second is to purchase insurance that covers the liability risks your business is likely to encounter.

While casualty and general liability insurance is broadly available, there is not insurance to cover all risks. For example, you can possibly purchase business interruption insurance to cover lost revenue caused by a fire, flood or condemnation, or even the dishonesty of an employee, but not low revenues because your products did not sell.

You should consider carefully the kinds of risks and liabilities your business could generate. If you provide technical writing services as an independent contractor, such as writing user manuals, your risks may be quite low. With appropriate errors and omissions insurance it may be feasible for you to operate as a sole proprietorship. If you haul hazardous wastes, it is unlikely that any attorney will recommend that you operate as a sole proprietor.

Ideally, you could both organize as a limited liability entity and obtain appropriate liability insurance. If your business has a low risk profile, and the simpler bookkeeping, state filings, and tax returns of a sole proprietorship appeal to you, that may be a good choice with appropriate insurance.

Have Questions?

A business lawyer can help you review in detail the pros and cons of being a sole proprietor. Together, you can decide if this is the best business structure for you. For more information you can contact one of Krigel & Krigel’s Business Attorneys.

Image: Thinkstock/Szepy
*This article is very general in nature and does not constitute legal advice. Readers with legal questions should consult with an attorney prior to making any legal decisions.

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