Starting or Own a Business? Consider if a Sole Proprietorship is Right for You

An uncertain economy and shaky job prospects are prompting many Americans to start their own businesses. This can be seen in rising female entrepreneurship, where stay-at-home moms and recent college grads alike are pursuing business opportunities.

While determining your own income offers great potential, the proper business structure should not be overlooked. Choosing the best legal structure affects taxes and personal liability, among other factors.

A sole proprietorship (SP) offers a convenient and low cost means to make your business official. Before choosing this structure, you should consider several factors. These include your business model and personality traits.

Here is an outline of SPs and if this legal structure may be appropriate for you:

Flexibility:

Sole proprietors do not need to build consensus with investors or other owners. This enables you to make business decisions quickly, which can be a competitive advantage.

Is your local economy in a downturn? You can quickly adjust prices or change suppliers to meet business trends.  If you enjoy control, an SP may be a good personality match.

Low cost startups or self-financed ventures are conducive to SPs. If you need financing, consider that venture capitalists such as Elliott Broidy and banks will often not lend to sole proprietors.

Since SPs can be transferred, selling your business to new ownership is relatively uncomplicated. If legacy is important to you, consider that sole proprietorships cease to exist if the owner dies or is incapacitated. Business assets are liquidated and passed on to beneficiaries in such cases.

Taxes:

From a tax standpoint, net profit or loss is filed on a Schedule C form, which outlines your revenues and expenses. The business income is then simply added or deducted from your 1040 personal tax return, if applicable. This simplicity saves money on accounting and filing fees that cut into profit margins.

In cases of a net loss, your personal income from other sources is reduced, which can cut a tax bill. However, SPs are required to pay self-employment taxes through a Schedule SE form. You can also hire employees within certain guidelines for additional tax breaks.

Liability:

Working alone offers quality assurance. You are solely responsible for completing the work and have discretion. By accepting the jobs that you feel most comfortable with, liability can reduced.

Despite the potential tax and productivity benefits of adding staff, your liability will also increase. Unlike a corporation, if an employee causes damage or commits unlawful acts, you could be held fully responsible.

It is important to consider this liability when expanding your business, particularly as a sole proprietor. You should have utmost confidence in staff to deal with customers in unsupervised situations.  If this causes anxiety, you may consider incorporating. Although legal risks can be subtle, review your business and determine the exposure to lawsuits.

The financial liability of an SP must also be considered. When business debts cannot be met, your personal assets could be at risk to satisfy obligations.

Will borrowing money be required to build your business? If so, review your personal finances to determine how much is at risk. For cases where a business loss would risk a large portion of your assets, consider incorporating for added protection.

Evaluate Legal Structure as Your Business Grows:

Business needs and operations are dynamic. As employees are added or services change, review your tax and liability exposure.

By understanding the pros and cons of being a sole proprietor, you can make informed business decisions.