Friday, February 7, 2014

Operating as a Sole Proprietorship - 1099s and Risk

Sole proprietors typically pay book keepers as independent contractors.
I often get questions on the subject of independent contractors vs. employees. Here is an article where I discuss the question in detail: Independent Contractors  or 1099 Employees - The Risks. The title is a bit ironic since you use a W-2 with employees and a 1099-MISC with independent contractors. When you operate your business as a sole proprietor, you typically bring on staff to work for you as an independent contractor. But be aware that just because you don't want to pay them as employees and go through the hassle of setting up payroll accounts to pay state and federal employment-related taxes, doesn't mean that whom you hire automatically qualifies as independent contractors.

If you, as a sole proprietor, have people who work for you but under their own supervision and work direction, then this "staff" may qualify as independent contractors. You pay independent contractors directly from the money you take in from clients. (If your clients split payment between you and someone else, you essentially operate under a partnership agreement, not a subcontractor or independent contractor arrangement.)

Your business' independent contractors make their own schedule (they choose whether or not to work or when to work), supervise their work product (although they must meet the minimum standards of your business) and pay their own taxes. For more detailed information on what arrangements constitutes an independent contractor arrangement, check out Can You Give Bonuses to Independent Contractors?

I never recommend operating as a sole proprietorship. Instead, I strongly recommend you formally structure your business as an entity separate from yourself. For most, the formation of an limited liability company is easiest if your state allows you to form a one-person / single member LLC. Not all states do. An LLC (or corporation) will protect your personal assets from liability if something happens. Get an EIN -- an employee identification number -- and run all your business activities under the LLC's name and EIN.

Example: A doll maker sold handmade dolls at flea markets in her area. One of the button eyes popped off and hit the toddler of one of her buyer's in the eye, causing loss of vision for the little girl  in that eye. The buyer sued the doll maker and the doll maker lost. Because the doll maker was operated as a sole proprietorship she was personally liable for all the debts and judgements against her business. She almost lost her home trying to comply with the $150,000 judgment against her and had to file for bankruptcy.

The motto of this story: You never know what could happen. You need to protect yourself and your business accordingly.

For tax information on 1099s, check out the special report: Business Owners, 1099s and W-9s: Answers to the 10 Most Pressing  Questions.

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