Drawbacks of Being a Sole Proprietorship

By  //  August 19, 2020

Being a sole proprietorship has its benefits but here are some of the drawbacks that you might not have known about. (Truic image)

Being a sole proprietorship has its benefits but here are some of the drawbacks that you might not have known about.  

A sole proprietorship is a type of business structure that most small business owners opted for; a sole proprietorship is an informal, unincorporated business that is not legally separated from its owner.

As a sole proprietorship, you will conduct business in your own name, including receiving and making payments, you will reap all the profits from your business yet you will also be solely responsible for any losses incurred by your sole proprietorship.

Forming a sole proprietorship is not easily done, and knowing all the drawbacks associated with it may increase your chances of success.

Is a sole proprietorship a separate legal entity?

This is a very important, if not the most important, drawback of forming a sole proprietorship. Your sole proprietorship is not considered a separate legal entity from you as its owner, and because of this, you are not granted limited liability and the protection of your personal assets.

This means that, as sole proprietorship business owner, your personal assets are at risk of being seized in the event of lawsuits filed against your business.

Your personal assets will also be at risk if you default on debt payments or if your sole proprietorship incurs any other financial loss. In other words, you will be solely responsible for all the debt, actions, and profits of your sole proprietorship, your wealth and personal assets will therefore be intrinsically linked to your business.

The important thing to remember is that you, as a owner of a sole proprietorship will be held fully liable and this may negatively impact your personal finances if you are not careful in business.  

Does a sole proprietorship provide tax advantages?

Because your sole proprietorship is not considered a distinct entity from you as an owner, your business won’t file separate tax forms, instead your sole proprietorship’s income will be reported on your personal tax returns. You will therefore pay income tax, but also self-employment tax on a yearly basis.

You will be required to pay self-employment tax because as a sole proprietor you are technically considered self-employed. This self-employment tax is  on top of and in addition to the federal, state and income taxes you will be required to pay.

A sole proprietorship does not afford you the tax benefits of say a Limited Liability Company (LLC) or a Corporation.

Single-member LLCs are taxed in exactly the same manner as sole proprietorships, it is therefore important that you do your research on each form or small business structure before you start your business.