THERE ARE A FEW GOOD REASONS why your accountant might suggest that it’s time for you to set up a formal business. If you’re running a business of any kind for profit but haven’t formalized your business entity, that is, register it with the Secretary of State, you are operating as a Sole Proprietor. A Sole Proprietorship is one way to run an informal business, which many people choose to do when first starting out. It may be simple and hassle-free, but it certainly won’t protect you and can cause a lot of problems such as having to pay higher taxes and expose your personal assets if you get sued. Some of the more common problems informal business owners face include liability for acts of negligence, personal injury and product liability, breach of contract, property damage and more.
Of course, you might be thinking, “But, I’m a fitness trainer who makes online videos. How could anyone possibly want to sue me?” Maybe you have a candle making side hustle or you’re a personal chef who only books private events. What’s the big fuss? Things are going fine and you certainly don’t expect anyone to have any issues with your product or service because you’re super careful about everything you do.
Well, just because you haven’t encountered major problems to date doesn’t mean that you won’t. Clients and customers who rely on your service or product could suffer some kind of injury from what you sell them and may need someone to blame. Or, a vendor you work with may disagree with the price or quality of something you provided and that could open you up to contractual disputes. In business, a thousand things can go wrong from day to day and if you’re an informal business, you are personally liable for the potential harm, physical and financial, that others may experience from working with you. Personal liability can mean that whatever you and your family own will be at stake to satisfy any harms or wrongs suffered by others as a result of your business-related activities.
Since accountants are often a first responder of sorts when it comes to your business or financial affairs, it’s common to learn from the person preparing your taxes each year that it might be in your best interest to protect yourself from both financial and legal liability. Unless you are fairly money savvy, your accountant knows more than you do and is looking out for your financial interests in a few important ways. Not only are they preparing your tax returns, making sure you are paying your fair share and complying with state and federal law, but accountants are vital advisors keeping you informed about important financial decisions that help to maximize your money to work for you instead of against you. Creating a formal business structure, securing insurance or estate planning are just a few ways your accountant is helping you.
Here are three things your accountant might be concerned about:
1. You might be unnecessarily paying too much tax on your business earnings.
2. You might be making too much money NOT to formalize your business structure.
3. You’re vulnerable to lawsuits based on the type of work you do.
Reduce Your Tax Burden
Sole Proprietors pay self-employment tax of 15.3% on net earnings from informal businesses. Since this is a tax concept, it’s best to have a heart to heart with your accountant to get the up-close and personal particulars, but just know that you can avoid this under certain circumstances by formally registering your business and working with your attorney and accountant to structure your business in a way to avoid this extra cost. To give you an idea of what this could mean for you, let’s say that 15.3% self-employment tax applied to $100,000 in earnings is an additional $15,300 paid to Uncle Sam. You get the point. When it comes to money and tax matters, the more you know, the more you know. For many, making sure you have a proper business structure can eliminate certain taxes and help you to reinvest those funds into your business to help it grow.
There’s No Such Thing As Too Much Money…Is There?
When it comes to being a business owner, actually, yes, it can sometimes be a bad thing. As a Sole Proprietor, which is considered a nontaxable entity, you might earn enough that not formalizing the business structure can actually become financially problematic. But, how is making more money problematic, you ask? Well, what if you have to pay employees or helpers? Having no formal structure puts you at a major disadvantage when it comes to hiring contractors, dealing with payroll issues, complying with workers’ compensation requirements under state law, dealing with health and safety matters, and the list goes on and on. State and federal laws really favor businesses that formalize into entities in order to gain the protections that the corporations and business codes were created to provide. Not only are there built-in consumer protections but safeguards specifically designed to help businesses - and the business owners - protect and enforce their rights. Smart money management for your business is made possible by following an established roadmap created for businesses to come into existence and grow over time.
Most people who start businesses aren’t really thinking about the topic of liability. Most of us start with a dream or a curiosity and set out to see where it takes us. Not everyone has a business advisor, coach or even lawyers to help them understand what they’re getting themselves into when they’re just starting out. They’re thinking about getting customers, making websites, learning about marketing, what computer systems to buy, paying employees and covering bills. A business owner’s mindset is often fixed on the management and financial responsibilities they take on, but a huge part of being financially responsible is learning how to anticipate problem areas and taking steps to avoid being liable for troubles arising from your business activities. Being the maker of a product or provider of a service makes you accountable to the people and other businesses that buy what you’re offering. If you make something someone consumes and they suffer a harm, you can surely expect they’ll come to you to fix it. If you’re operating informally, then you’re an individual dealing with another individual customer who may be unhappy or harmed and this enables them to look to your personal assets to compensate them for any suffering. However, a business owner who forms a company or corporation has the entity to shield the owner personally from harms suffered as a result of certain business activities. In addition to rules and regulations meant to keep businesses on track legally, structured businesses also provide access to certain resources such as business insurance, opportunities with membership organizations, and educational tools that help to set performance standards and customs.
A common problem occurs when two or more people go into business together without a formal structure and a disagreement turns sour and impacts the entire business operation when things ultimately can’t be worked out. Now that it’s easier than ever to start building a business with little more than a healthy dose of ambition and a cellphone, solo and small business ownership, especially among women, is on the fast rise with significant increases seen year over year. Solo and small business owners are especially at risk because so many operate on a shoestring without a lot of resources. Having the right business structure in place is often essential to a business’s survival when trouble comes calling.
If your accountant has recommended you set up your business structure, be sure to get in touch with an attorney to get your business entity formed properly.