Sole Proprietorship Liability and How to Protect Yourself

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A sole proprietorship is one of the simplest forms of business structures with a single owner. Even though a sole proprietorship business may offer an easy formation process, it becomes hardly impossible to avoid liabilities. Learn how sole proprietors can protect themselves, their assets and their business. 

Key Takeaways

  • Sole proprietorships are a business structure where a single owner has all control over a business
  • Sole proprietorships are easy to create and do not have many formal requirements
  • Biggest disadvantage of sole proprietorships is unlimited personal liability, which means your personal assets aren't protected from liabilities of your business
  • Ways to protect to protect personal assets from business liabilities include insurance, restructuring ownership of your home and hiring independent contractors

What Is a Sole Proprietorship?

In a sole proprietorship, the business is owned by a single person who fully operates it and has uninterrupted control over business operations. In essence, the owner is not obligated to file with the secretary of state or the registrar of companies to create the business.

It does not require the formalities that are followed by corporate entities such as the obligation to hold an annual meeting or to keep the minutes of meetings. 

Unlimited Personal Liability

While a sole proprietorship and its features of having complete and uninterrupted control over the business may seem encouraging, its principal drawback revolves around the fact that as the business owner, you are personally liable for all the liabilities that the business incurs.

There is practically no legal distinction between the owner and the business in a sole proprietorship, meaning the authorities such as IRS and the state government do not, in any way, consider your business activities as being separate from your personal transactions.

In other words, it also means creditors of the business owner or of the business itself, as well as any other entity or individual who has any claim against the owner, can reach both the business and the owner's personal assets.

Ways to Protect from Liability in Sole Proprietorship

As business owners, no one would want to undergo catastrophic financial consequences arising from liabilities that would otherwise be avoided. Here are ways to protect yourself from such liabilities.

Obtain Insurance

There is business liability insurance that can perfectly protect a sole proprietor from liabilities such as lawsuits that would derail the business and deplete personal assets. While it may be an expensive option, especially for small business owners, it can protect sole proprietors from many events that would be financially devastating to the business.

You could consider the following types insurance for your business:

  • Against lawsuits: general liability, E&O insurance, professional liability
  • Property damage: commercial property insurance and business owner's policy, commercial auto policy
  • Loss of income: business income interruption insurance
  • Employee injury or illness: workers' compensation insurance

Another way to protect your business from lawsuits is to have your customers sign a liability waiver in case they sustain injuries from a risky activity that is part of the services you offer.

Protect Your Home from Liability

In many cases, a person's home is his/her most prized asset that would be targeted if a massive liability claim arises. With this in mind, protecting your home from liability that revolves around operating a sole proprietorship business would be the first priority.

For married individuals, it may be wise to consider changing the title of the house so that it includes you and your spouse as tenants by entirety.

It would mean that the property is shared on a 50-50 basis. It would then effectively hinder creditors from placing a lien on the property because the debts owed only relate to you individually as the sole proprietor of the business and not your spouse.

On the other hand, unmarried sole proprietors can consider owning the home with someone else other than a spouse, say with your parent. Remember that this provision always differs depending on the laws of each state.

Hire Independent Contractors

According to most business laws, a sole proprietor is not responsible for damages or negligent acts caused by independent contractors. In this regard, a sole proprietor can consider hiring the services of an independent contractor for all the staffing needs, instead of employees. Anyway, keep in mind that this provision may vary from state to state, especially where negligent acts are involved. For example, sole proprietors in California can be responsible for a contractor's negligence if the job for which he/she hires the contractor is inherently dangerous.​

Create an LLC

While all the above ways can protect a sole proprietor and his/her business from liability, the most effective and inexpensive way of liability protection is to effectively change the business from a sole proprietorship to a ​Limited Liability Company (LLC).

An LLC comes with numerous benefits not only to the business but to you as the business owner. It gives you the chance of separating your business entity from personal activities, meaning that creditors cannot target your personal assets to satisfy liabilities of the business. 

Frequently Asked Questions (FAQs)

Why is unlimited personal liability the biggest disadvantage of a sole proprietorship?

Sole proprietorships offer many advantages for small business owners such as complete control and little requirements for formal organization. However, in a sole proprietorship, there is no legal distinction between the business and the business owner. Which means, while all profits go the the business owner, they are also personally responsible for liabilities. So if for some reason the business is unable to pay its debts or taxes, authorities can take out liens against the personal assets of the business owner.

What is liability insurance for a sole proprietorship?

Sole proprietorships, like any other business, face the possibility of liabilities but may need insurance more because a business owner is personally liable in a sole proprietorship. Sole proprietors could get general liability insurance to protect themselves against lawsuits, and property damage. Professional liability insurance or E&O insurance can also provide cover for liabilities against negligence. Business owners should also consider workers' compensation insurance, commercial property and auto insurance among other insurance options.

Article Sources

  1. Cornell Law School Legal Information Institute. "Sole Proprietorship."

  2. Internal Revenue Service. "Sole Proprietorships."

  3. The Hartford. "Sole Proprietorship Insurance."

  4. ADP. "Can a sole proprietor have employees?"