Sole Proprietorship

Sole Proprietorship Legal Implications: Here’s What You Need to Know

Finance 5 Mins Read July 13, 2022 Posted by Soumava Goswami

Last Updated on: November 15th, 2024

A sole proprietorship can have a lot of benefits for small traders. They allow them to get up and running as fast as possible, and when you are a small operator who only has to worry about a handful of clients, it doesn’t make much sense to go for a corporation.

Furthermore, when it comes to selling your business, this process is a lot more simple than if you were to run a corporation.

An LLC might also be too much for you since it has a structure that is too complex. However, sole proprietorships do come with their share of risk. If you still feel like a sole proprietorship is the best option for you.

Sole Proprietorship As A Business

A sole proprietorship is a business that only one person owns without incorporation. Although the owner of the business pays tax only once, it has fewer financial and legal protections. On the other hand, a corporation offers financial and legal protection to its owners.

Since a sole proprietorship is not a corporation, both the owner of the business and the business are one person by law. Hence, there is a disadvantage in the form of legal and financial protections. Moreover, the owner gets less guidance on business practices. Also,  the owner might face difficulties in getting funding for the business.

Furthermore, the health benefits are also expensive for owners of sole proprietorships. Also, if the owner takes a day off, performing basic business tasks becomes difficult.

Let?s take a look at some of your legal obligations as a sole proportioner and how to protect yourself.

1. Your Business and Personal Debt are Intertwined

The biggest difference between operating as a sole proprietor and as an LLC or corporation is that your personal debt and your business debt will be tied together. So, if you have an account in collections and there’s a judgment against you, you may have to liquidate some or all of your business?s assets to cover the costs.

Moreover, if your business owes a supplier or gets in a lawsuit and you have to pay up, both your assets and your company’s assets could be accessible.

2. Reporting Taxes as a Sole Proprietor

Since you and the company will be viewed as one and the same by the IRS, you will have to report your taxes differently.

The IRS views your company as a pass-through entity. Here, you have to report your profits through your personal tax income return. You?ll also have to pay for Medicare and Social Security. You will learn about this part at a later point in this article.

3. Protecting Yourself as a Sole Proprietor

Since your assets will be exposed as a sole proprietor, you need to take extra precautions when dealing with clients and when setting up your business. It all starts with getting proper coverage, but there are plenty of other things you can do.

Don’t think that you can put barriers between your personal finances and your business finances. Also, you do not have to use your name for everything.

It is possible to do several things with a DBA or a trading name including opening credit accounts. Therefore, opening business-related accounts will help manage your business?s finances. Also, you can improve your business?s credit score.

4. Dealing with Personal Debt

You will also have to be very careful about how you handle personal debt as a sole proprietor. This means paying your accounts on time and getting a copy of your credit report from all three major agencies to spot any irregularities.

If you have problematic accounts that have been transferred to collections, then we suggest you speak with them directly. Then, see whether you can come to an agreement.

You should also know the rules governing interactions with debt collections. This is because they can get very aggressive, especially when they know you have a business.

If you think that you are the victim of debt collector harassment, we suggest you check out the Fair Credit law firm. Teams like these will be able to tell you if you are dealing with harassment and make it stop while providing solutions on how to deal with the claim.

You need to know what your level of responsibility is when running a sole proprietorship. This will allow you to stay out of trouble. Also, it will push you to move more cautiously so you can avoid legal issues.

5. High Self-Employment Taxes

For an employee working as a W2 worker, the employer is responsible for paying a percentage of Social Security taxes for the employee. However, as a sole proprietor, you have to pay the tax for both the employee and the employer. Hence, you have to take the full burden of the tax to yourself.

Here, as a sole proprietor, you have to pay both Social Security taxes and medicare taxes. However, there is also good news for many business owners. Basically, the Above-the-line tax deduction allows you to take back one-half of your self-employment taxes.

This comes in the form of a tax deduction. This means you do not need to pay taxes on your gross earnings.

Reporting Taxes as a Sole Proprietor

There are some solutions that can help you deal with the disadvantages of sole proprietorships. With those solutions, you can have better control of your business. Basically, you can benefit from forming a business or doing simple filings.

For example, like many sole proprietors, you can overcome these disadvantages by getting advice from business mentors. Apart from that, you can also get alternative funding. establish contractual agreements, or tap into various tax breaks. Also, you can save for days when things go down.

Wrapping Up

Hence, you can see that there are many sole proprietorship legal implications. One of the best ways to deal with these implications is to incorporate your business. If you are not willing to incorporate your business, make sure you take the help of a business mentor and a tax advisor to learn about various benefits and tax breaks.

Do you have more suggestions to offer on how to solve the problems of sole proprietorship? Consider sharing your ideas and opinions in the comments section below.

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Inspired by The Social Network, Soumava loves to find ways to make small businesses successful – he spends most of his time analyzing case studies of successful small businesses. With 5+ years of experience in flourishing with a small MarTech company, he knows countless tricks that work in favor of small businesses. His keen interest in finance is what fuels his passion for giving the best advice for small business operations. He loves to invest his time familiarizing himself with the latest business trends and brainstorming ways to apply them. From handling customer feedback to making the right business decisions, you’ll find all the answers with him!

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