Ways to Protect from Liability in a Sole Proprietorship

By Tom Speranza, J.D.

Ways to Protect from Liability in a Sole Proprietorship

By Tom Speranza, J.D.

A sole proprietorship is the simplest form of small business—you own and operate the business in your personal capacity (not through a separate business entity) and report its income, losses, and expenses on your personal tax returns.

Man on computer in living room

Primary Risk of a Sole Proprietorship

The biggest downside of a sole proprietorship is the lack of limited liability. When you run your business through a corporation or limited liability company, your liability for debts and legal claims is limited to the assets of the company.

In contrast, a sole proprietorship exposes your personal assets to the creditors of the business—and the customers and others who may file legal claims against you. For example:

  • An unpaid supplier can sue you, obtain a judgment, and pursue assets like your car and personal checking account to satisfy the debt.
  • A pedestrian who slips and falls in front of your store can sue you for his injuries and place a lien on your house to secure payment of the damages awarded by the jury.

How to Reduce the Risks of a Sole Proprietorship

Even if you decide to continue running your business as a sole proprietorship, there are ways to reduce the inherent risks of unlimited personal liability.

Buy insurance.

Business insurance can protect you from legal claims that could wipe out your personal assets.

  • General liability insurance protects you from accidents that happen at your business location or when you're working at a client's business. For example, it provides coverage for claims arising from employees and contractors falling down or being hurt by equipment, as well as customers or others being injured in and around your office or store.
  • Commercial auto insurance protects you from accidents involving the vehicles you and your employees use on the job—even if you use your personal vehicle.
  • Errors and omissions (or professional liability) policies provide coverage for mistakes your business makes when it provides products and services to customers. This is crucial insurance for consultants and professionals like accountants.

Of course, all insurance has deductibles and policy limits, but a risk management plan that includes policies issued by reputable insurers can dramatically reduce the chance that a legal fight will bankrupt you.

Transfer personal assets.

You can shield some of your personal assets from creditors and plaintiffs by transferring them to other people. If you bought a house when you were single, but now you're married, consider a transfer of title from yourself individually to you and your spouse as "tenants-by-the-entireties" (a form of legal ownership that gives each spouse a 100 percent interest in the property). Someone with a claim against you individually cannot place a lien or attach a house owned in that form.

You can also transfer ownership of vehicles (another high-value asset) from yourself to your spouse or other family members.

Just keep in mind that you can't start moving assets around once someone has made a legal claim against you. If you try to hide assets in those circumstances, the creditors and plaintiffs can make claims for fraudulent transfers and pursue them anyway.

Property law is complicated and transfers can create taxable events if you're not careful. You should consult a lawyer admitted in your state before making any transfers.

Comply with the law.

It sounds obvious, but a surefire way to reduce the potential for unexpected business liabilities is to follow the law:

  • If your municipality or state requires business licenses or permits to run your business, fill out the applications, pay the fees, and make sure your business is compliant. If the licenses require periodic renewal, keep track of their expiration dates.
  • If you have employees working for your business, pay their wages and tips on schedule, withhold and pay to the tax authorities all of the required employee and employer taxes, obtain workers' compensation insurance, and don't create conditions at work that could give rise to discrimination or wrongful termination claims.

Write good contracts.

Read your contracts with customers, vendors, suppliers, and contractors carefully before you sign them. The goal is so to make sure they accurately spell out the business and legal terms that you and the other party negotiated. If a proposed contract is incorrect, call the other side, try to negotiate revised language, and resolve the dispute.

Other business documents you use—such as invoices, engagement letters, purchase orders, sales orders, and disclosures on your website—should also be written carefully with an eye toward avoiding ambiguity and unexpected disputes.

An experienced business lawyer can help you create a standard set of transaction documents that keeps you out of trouble.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.

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