Liability and the Unincorporated Business

The liability issue is something you can’t ignore. That’s because in a sole proprietorship there’s no barrier between you and your business. If your business can’t pay its bills, creditors look to you personally to make up the difference. If your business buys a vehicle, you buy that vehicle. If a client gets angry and sues the business, 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. In this instance, no cost equals no protection.

A general partnership is worse. Why? Because you take all the bad things that a sole proprietorship offers and you double them to include your partner. Anything your partner does affects you just the same. If your partner decides the business needs a car he or she can enter into a lease or sale agreement without your agreement – but you’re bound to the deal, all the same. If the business can’t pay its bills, you get stuck with the fallout. And if your partner disappears, you get to face that fallout alone.

Increased Taxes and the Unincorporated Business

If you’ve ever collected a paycheck, you know that in addition to income tax you also have deductions from your pay for Medicare and Social Security. Together those amount to about 7.65% of your gross pay. Your employer is required to match those amounts, meaning that just over 15% is paid into Medicare and Social Security on your behalf. We call these your FICA taxes, and they are in addition to your federal and state income tax.

When you are self-employed, as a sole proprietor or in a general partnership, and you are generating income from the sale of goods or services, you also have to contribute to Social Security and Medicare. But now you are responsible for paying both the employee and the employer share of your FICA taxes. For the self-employed person, this is called Self Employment Tax.

Paying Self Employment Tax is a big financial hit for many people. You can minimize that tax, though, in the right business structure. You can even avoid it entirely on part of your income, in the right business structure. But sole proprietorships and general partnerships don’t qualify for this relief. If you operate in either of these structures, you can’t escape Self Employment Tax.
In the self-assessment exercise (you’ll find at the end of this eBook), we ask you to take a look at line 56 on your most recent personal tax return. If there’s an amount in it, divide that in half. The amount you come up with is about what you’ll save every year moving over into a good business structure. It’ll actually be a bit less, but for the sake of this argument, go with the half. Depending on how much you’re paying in self-employment tax, incorporating might be one thing you can do right now, to save money.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

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