Guest Author - Mary Salzman

In the first article in this series on accounting for sole proprietorships I discussed the advantages to selecting the sole proprietorship type of business entity.

This article will deal with three major disadvantages and how to account for them:

1. Owner Liability
2. Fringe Benefits
3. Self Employment Tax

Owner Liability - as the owner of a sole proprietorship you are not protected by the limited liability aspect of incorporation. I have found this to be a twofold problem: responsibility for the debts of the business and product liability.

Let’s discuss business debts first. Sole proprietors are personally responsible for all debts of the sole proprietorship. However, as a brand new business you, the owner, will more than likely be asked to guarantee any business debt regardless of your entity selection.

So even if you were to incorporate you would more than likely be asked by the lender to personally guarantee the unpaid debt of the business. As a CPA I’ve had corporate clients with excellent credit, in business for decades, apply for loans and still the president of the corporate was required by the lender to cosign the loan paperwork.

All debts of the sole proprietorship are reflected on the balance sheet of the proprietorship as either a long (portion of the debt extending beyond a year) or short tem liability.

Product Liability – if you are selling an edible good or a product that could potentially be used in a harmful fashion the sole proprietorship type of business entity is not going to work for you. Consult an attorney for advice in establishing a business in your local area.

Sole proprietors cannot deduct the cost of their fringe benefits as a business expense. In this article I am going to discuss the major sole proprietor fringe benefit – that of health insurance. As a sole proprietor the cost of your health insurance is taken as a deduction on page 1 of Form 1040 as a deduction from adjusted gross income.

It used to be that the sole proprietor could only deduct varying percentages, up to 80% of the cost of health insurance. A few years ago this section of the tax code was changed to allow a 100% deduction. This change made a substantial difference in the amount of income tax owed by the sole proprietor. This change did not affect the amount of self-employment tax owed.

The self-employment tax of the sole proprietor can be compared to the FICA tax withheld from the gross wages of a normal W-2 employee. Here is how it works as an employee: up to a certain dollar threshold 7.65% is withheld from your paycheck for FICA tax; your employer is required to match your contribution for a total of 15.3%.

As a sole proprietor there is no employer (you are in essence the employer) to match your contribution so you are responsible for the entire portion. And self-employment tax is paid on the net income of the business – your cost of fringe benefits is not a deduction for the computation of this tax.