When setting up a new business structure, it can be tempting to select a sole proprietorship simply because you don’t have to do anything to start one.
You simply operate your business in your own personal name, or through a fictitious name, without even opening a separate bank account.
This particular structure is also called a Schedule C business, because when you file your personal 1040 tax returns, the income and expenses for your business are reported on a Schedule C that’s attached to it.
Even though the sole proprietorship is easy, there is a great deal of risk that comes along with it. So before you decide to go the easy route, let me share with you the dangers of a sole proprietorship, and why you should consider incorporating your business.
Liability is a major issue. In a sole proprietorship, there’s no barrier between you and your company. If the company can’t pay its bills, creditors will look to you personally to make up the difference. If the company buys a vehicle, you buy that vehicle. If a client gets angry and sues the company, you get sued too!
If you have employees and they get into trouble on the job, it’s your trouble, too. You and your business are inseparable. You’re one big target. Even though there’s no cost in selecting a sole proprietorship, there’s no protection either.
Anyone who’s ever collected a paycheck knows that you lose 6.2% of the first $106,800 of your gross salary to Social Security, and another 1.45% for Medicare (except Medicare has no cap – you pay on every dime you make).
But what you may not know is that employers are required to match those amounts, along with any state payroll tax amounts. So that’s a minimum of 15.3% right off the top of your income. In the right incorporated business structure, you can minimize the hit and avoid payroll taxes on a good portion of that income. If you’re using a sole proprietorship, you’re stuck.
According to the IRS’s own statistics, sole proprietorships have a one in seven chance of being audited, versus one in fifty or higher for incorporated businesses. The IRS figures that the more casually a business is operated, the more likely it is to have some mistakes in its record keeping, and improper deductions that can be denied or reduced.
If you’ve been doing business up to now as an unincorporated business, both the IRS and your state government defaults your business into either a Sole Proprietorship or a General Partnership.
As a business owner, the first step is to avoid the dangers of a sole proprietorship so you can stop putting your personal credit and assets at risk.