Nearly 75 percent of small businesses are structured as sole proprietorships. This is because, in general, sole proprietorships are easy and inexpensive to form and maintain, and you won’t be required to separate your business and individual tax returns. But despite these great benefits, a sole proprietorship can actually hold you back as your business becomes larger and more profitable. Here are 4 signs you need to change your business structure:
- You Need Greater Protection From Personal Liability
When you operate your business under a sole proprietorship you and your business are basically one and the same. This means there is no legal separation between the two and you would be personal liable if your company was sued or if you aren’t able to pay back a business loan sufficiently in the future. On the other side, S corporations, C corporations and LLCs have more limited personal liability, which can be of great benefit to you as your business continues to grow.
- You Require A Loan
The second of the 4 signs you need to change your business structure is that you can have a more difficult time obtaining a loan as a sole proprietor. Sole proprietors are the only owner of the business, which means you would be unable to sell any business shares for equity funding. You would also be required to offer personal assets as collateral if you decide to pursue a loan for your business. The Small Business Administration also stated in a recent report that banks aren’t as likely to loan money to a business classified as a sole proprietorship due to a perceived lack of credibility.
- You Are Getting Hit On Your Taxes
Sole proprietorships are attractive because of the ease in filing taxes. However, all net income received as a sole proprietor is subject to full income and payroll taxes. In fact, sole proprietors are required to pay the entire 15.7 percent of Medicare and Social Security payroll taxes because the owner is classified as both the employee and the employer. These additional taxes can add up quickly, especially as your business becomes more profitable.
If you designate your business as an S corporation you will have the potential to lessen your tax burden as your business makes more money. As the owner of an S corporation you would be required to pay yourself a fair market salary, which would be subject to income and payroll taxes. But you would also be able to pay yourself some in the distributions, which are not subject to payroll taxes. If your business makes a lot of money, this distinction could potentially save you thousands of dollars a year in tax payments.
- You Are Getting Close To Retirement
The final of the 4 signs you need to change your business structure is that a sole proprietorship can’t be transferred to another person when you decide to retire. Sole proprietorships by definition can’t have more than one owner, which means you won’t be able to gift or transfer any part of your business to another person even if you hoped to give your business to a relative. There are also extensive tax implications if you pass away. Your sole proprietorship would pass away with you and all the assets associated with that business would become part of your estate. If your estate is large this could lead to a big tax liability for your heirs.