This year is winding down and I’m willing to bet you’ve already got big plans for 2016. Maybe your plans even include forming a new business! That is awesome!
As a new business owner, one of the first and most important decisions you will face is how to structure your business. You have your pick between a sole proprietorship, a partnership, a corporation, or a limited liability company. Each structure has its advantages and disadvantages, and each should be given consideration before you open your business to the public. However, sole proprietorships, where the owner and the business are one single entity, have recently become a popular trend because of their minimal start up costs, easy management, and rewarding sense of independence. While these benefits may sound appealing, here are 3 reasons why you should reconsider being a sole proprietor:
1. High Degree of Liability
Because the owner and the business are indistinguishable, business creditors can make claims directly against the owner. Thus, a sole proprietor is responsible for any and all debts that the business incurs, and if they cannot fulfill the debt, then creditors can go after the sole proprietors personal funds and property. Debts taken on by corporations and LLC shareholders, on the other hand, usually live and die with the company.
2. Limited Ability to Raise Capital
Only one owner is allowed in a sole proprietorship, so it cannot sell shares or interests in order to raise capital like a corporation. Also, banks generally lend less to sole proprietors and subject them to much more scrutiny.
3. Self-Employment Tax
All the earnings of a sole proprietorship are subject to the IRS self-employment tax. Corporations, on the other hand, benefit from more lenient tax regulations and a large number of tax write-offs. Thus, in a sole proprietorship, the entire earnings will be taxed twice: once for self-employment taxes, then again for normal income tax purposes since the business and owner are indistinguishable. This can result in thousands of dollars of hard earned profit being taxed in excess.
Keep your mind open when thinking about a business structure, do not base your choice on just cost and ease. Also, if you have a sole proprietorship already and face some of these problems, then don’t worry, you can always change the company structure and reap the rewards!