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Sole Proprietorship Bankruptcy: What's at Stake

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By Neetal Parekh on September 28, 2009 2:01 PM

In the excitement of driving a new business off the lot, many entrepreneurs gloss over the different business organization types available.  This is especially true for individuals looking to start a small business or home-based venture who turn to sole proprietorship as a way to get started quickly and avoid the expense of incorporation, legal fees, and other filing considerations.

And for many sole proprietorships, the combination of insurance coverage, keeping overhead costs low, and generating consistent revenue is enough to survive and even flourish.  However, when the economic forecast delivers storms, small businesses may find making ends meet to be an insurmountable challenge.  And many sole proprietors do not realize that, when it comes to bankruptcy for small business, their personal assets can be seized.

Here are some important facts about sole proprietorship and sole proprietorship bankruptcy that you should know:

  • a sole proprietorship, unlike a limited liability company (LLC), is not a separate entity from its owner
  • sole proprietors must file business income or losses as part of their personal income tax returns
  • sole proprietors must contribute to Social Security and Medicare
  • a sole proprietor is personally liable for all business-related debt or court judgments, including in the case of sole proprietorship bankruptcy
  • creditors can go after a sole proprietor's home, car, personal bank accounts, and other assets to recover unpaid debt
  • insurance cover can shield a sole proprietor from certain personal liability, but generally cannot protect a sole proprietor from creditors' claims
  • a sole proprietorship exists so long as the owner is alive.  It is up to the owner to make estate planning provisions if he/she wants the business to continue on after death

Overall, a sole proprietorship is a quick way to get a venture running, which could be key in raising capital.  However, as your small business becomes more financially viable, it is key to consider incorporation to protect yourself from being held personally liable for the business and to create infrastructure that will enable future growth for your venture.

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