Sole Proprietorship Liability & How to Protect Yourself
It is common knowledge that a sole proprietorship is one of the simplest forms of business structures. In a sole proprietorship, the business is owned by a single person who fully operates it and has uninterrupted control over business operations. In essence, the owner is not obligated to file with the secretary of state or the registrar of companies to create the business. It does not require the formalities that are followed by corporate entities such as the obligation to hold an annual meeting or to keep the minutes of meetings.
While a sole proprietorship and its features of having complete and uninterrupted control over the business may seem encouraging, its principal drawback revolves around the fact that as the business owner, you are personally liable for all the liabilities that the business incurs. In other words, the authorities such as IRS and the state government does not, in any way, consider your business activities as being separate from your personal transactions. Even though a sole proprietorship business may offer an easy formation process, it becomes hardly impossible to avoid the following liabilities.
Unlimited Personal Liability
Any sole proprietorship business will come with unlimited personal liability. There is practically no legal distinction between the owner and the business, meaning that creditors of the business owner or of the business itself, as well as any other entity or individual who has any claim against the owner, can reach both the business and the owner's personal assets.
Ways to Protect from Liability in Sole Proprietorship
As business owners, no one would want to undergo catastrophic financial consequences arising from liabilities that would otherwise be avoided. Here are ways to protect yourself from such liabilities.
There is business liability insurance that can perfectly protect a sole proprietor from liabilities such as lawsuits that would derail the business and deplete personal assets. While it may be an expensive option, especially for small business owners, it can protect sole proprietors from many events that would be financially devastating to the business.
Protect Your Home from Liability
In many cases, a person's home is his/her most prized asset that would be targeted if a massive liability claim arises. With this in mind, protecting your home from liability that revolves around operating a sole proprietorship business would be the first priority. For married individuals, it may be wise to consider changing the title of the house so that it includes you and your spouse as tenants by entirety.
It would mean that the property is shared on a 50-50 basis. It would then effectively hinder creditors from placing a lien on the property because the debts owed only relate to you individually as the sole proprietor of the business and not your spouse.
On the other hand, unmarried sole proprietors can consider owning the home with someone else other than a spouse, say with your parent. Remember that this provision always differs depending on the laws of each state.
Hire Independent Contractors
According to most business laws, a sole proprietor is not responsible for damages or negligent acts caused by independent contractors. In this regard, a sole proprietor can consider hiring the services of an independent contractor for all the staffing needs, instead of employees. Anyway, keep in mind that this provision may vary from state to state, especially where negligent acts are involved. For example, sole proprietors in California can be responsible for a contractor's negligence if the job for which he/she hires the contractor is inherently dangerous.
Create an LLC
While all the above ways can protect a sole proprietor and his/her business from liability, the most effective and inexpensive way of liability protection is to effectively change the business from a sole proprietorship to a Limited Liability Company (LLC). An LLC comes with numerous benefits not only to the business but to you as the business owner. It gives you the chance of separating your business entity from personal activities, meaning that creditors cannot target your personal assets to satisfy liabilities of the business.