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What Are the Disadvantages of a Sole Proprietorship?

By Ray Hawk
Updated May 17, 2024
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A sole proprietorship is one of the easiest types of business structures legally allowed within the United States, yet it has distinct disadvantages over the rights and responsibilities of limited liability corporations (LLCs), partnerships, and other more formal business structures. One of the fundamental disadvantages of a sole proprietorship is that all liability incurred by the company or its employees is solely the responsibility of the owner. This extends to all personal assets of the owner, such as a home, car, personal savings, and real estate, which may need to be surrendered if the business is sued and that lawsuit is lost in court. Liability protection in terms of business insurance is always recommended for a sole proprietorship, but, at the same time, it is expensive to obtain.

Businesses licensed as a sole proprietorship also have a rather vague status in tax law, which can create tax issues that are difficult to resolve. The federal government looks at a sole proprietorship in a similar way to that of someone holding a job, and taxes are paid based on the income that the business generates. This can vary significantly depending on if the business claims a net profit or loss, and what the owner periodically pays himself or herself in terms of a salary. Personal tax deductions and tax brackets that an owner claims can therefore be altered both by the assets and profits of the business, as well as the income that the owner arbitrarily chooses on a year-by-year basis. This can make complying with local, state, and federal tax laws a complicated affair.

Another key aspect of a sole proprietorship that is traditionally seen as a weakness of the business format is that such businesses are almost invariably very small and speculative. Such status may give the business a less-than-professional appearance as compared to larger, established competitors. This also makes it nearly impossible for a sole proprietorship to obtain growth or start-up funding from commercial banks or venture capitalists. Often, if funding is available, it comes with high interest rates, or the requirement that the owner surrender controlling interest in the business to the organization providing the loan.

Self-employed individuals often start sole proprietorship businesses as their income grows, as the business structure is relatively easy to establish with minimal legal paperwork to process. These very facts of self-employment act against a sole proprietorship by making it vulnerable when conflicts occur between corporations with lengthy legal protections, or governments with complicated regulations and taxation codes. Agencies such as the Internal Revenue Service (IRS) in the US may scrutinize sole proprietorship tax filings in a much more minute manner than those of corporations due to the fact that there are so many avenues to declaring business profit or loss and deductions through small businesses. Taxes are often estimated and paid quarterly, which may lead to errors in filing by owners who are not intimately familiar with complicated tax laws.

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