Do Business the Right Way: Why Doing Business Under Your Own Name is a Mistake.

If you engage in business under your own name, you are operating as a sole proprietor (“sole prop”). The sole prop is the default form of business structure, and it also happens to be the worst.

If you are a sole prop take this as your sign to call an attorney and re-evaluate your business structure.

Why is a Sole Proprietorship a Bad Way to Conduct Business?

Two primary reasons: tax strategy and asset protection.

1.) Sole props lose an opportunity for massive tax savings.

When you operate as a sole proprietor you are subject to to something called “self employment tax” on 100% of your income from the business. The self employment tax rate is 15.3%. When you are a W-2 employee, your employer pays half of your Medicare and Social Security for you (your employer’s share of this is referred to as “payroll tax”). When you are self employed you have to pay your share as both employee and employer.

An example: If you earn $100,000, your self employment tax as a sole proprietor is $15,300.00. Keep in mind this self employment tax is IN ADDITION TO your normal income tax. In this scenario, it would not be uncommon for the $100,000 earner to pay an additional $12,000 in income tax, making the total tax burden $27,300.00. As a sole proprietor there is no way to avoid the self employment tax other than failing to report income (which is a crime and we would not recommend).

If you optimize your business structure and take advantage of basic tax strategies, it would be easy to reduce the self employment tax by at least $9,000 per year. These savings become even more significant the more your business earns. More careful planning can unlock even more tax savings with strategies that are unavailable to sole props.

2.) Sole props leave individuals wide open to liability exposure.

Operating as a sole proprietor leaves all of your assets exposed for any liability resulting from your business. Even if you are very careful, accidents and unhappy customers can be a reality of business. If you operate as a sole proprietor a person suing your business can potentially come after all of your personal assets. Also, your business assets are at risk as a result of any of your liability in your personal life.

When someone sues you for money and wins they obtain a judgment against you. That judgment can be filed and a lien attaches to all real property held in your name. That means if you make a mistake at work, a lawsuit can lead to your personal residence having a lien against it. Additionally, a judgment creditor can take measures to freeze funds in your personal bank account and garnish your wages.

Operating your business under your own name gives your creditors a wide array of tools to collect against you. You can mitigate this risk by running your business operations under a separate entity.

A Note on DBAs and Partnerships:

Filing a d/b/a in the County Clerk’s Office is not sufficient. For tax purposes, you are still treated as a sole proprietor and any liability that attaches to the business still falls on you personally. The only thing a d/b/a does is allow for you to open a bank account using another name and to advertise your services under a name other than than your own. However, you are STILL a sole proprietor-even with a d/b/a filed.

A partnership is very similar to a sole proprietorship from a tax and legal perspective. Where a sole proprietor is an individual, a partnership is with more than one person. Similar to a sole prop, we highly discourage partnerships for the same reasons we discourage sole props- along with plenty of other reasons.

Conclusion

Having a sound business structure matters for small businesses. Not only can it save you thousands of dollars in taxes, it also allows to keep your assets separated. If you are thinking about starting business, it pays to talk to an attorney who knows what he is doing to help you structure your business and guide you. If you have been operating your business as a sole prop or partnership, it is not too late to make a change and tap into massive savings and asset protection!