Regulation of Sole Proprietorships: A Case Study of Joe the Destroyer
Regulation of Sole Proprietorships: A Case Study of Joe the Destroyer
The case of Joe who opened a start-up called ‘Joe the Destroyer’ is a typical example of the unregulated procedures involved in setting up a sole proprietorship. His blunder when he accidentally destroys a wrong house also highlights the legal problems that face sole proprietors. Under most legal systems, including the U.S, a sole proprietorship is the easiest and simplest form of business to start (Longnecker et al., 2010). Unlike other forms of businesses, such as the Limited Liability Companies (LLCs) or corporations that require a lot of complexities to commence, proprietorships require little or no formal declarations. For this reason, there are so many people engaging in this form of business because commencing it is undemanding.
Nonetheless, the existence of loose legislation regarding the establishment of proprietorships does not exempt them entirely from the parameters of business regulation. Instead, the wobbly laws make venturing into them very risky and costly, especially if they experience unprecedented debts or accidents. Even though Joe’s easy entry into business highlighted the swiftness of setting up a proprietorship, his accidental demolition of a wrong house brought into view three legal problems that proprietorships have to deal with, including unlimited liability, ambiguous tax burden, and lack of a comprehensive insurance cover. This paper will look into each of these three legal problems and establish how they apply to sole proprietorships similar to that of Joe.
Liability simply refers to the obligations business owners or shareholders have to pay the debts incurred by their entities. Whereas in corporations or LLCs liability is limited to the number of shares a particular shareholder holds, in sole proprietorship an owner has unlimited liability that requires him or her to offset all the debts. The reason behind this is because a sole proprietorship is basically a business entity that is legally owned by one person or a couple who share a joint tax burden. Within the confines of law, this business entity has a similar legal identity as that of its owner (Cole, 2011). For this reason, the owner is personally responsible for all the actions of his or her enterprise. In addition, it also means that all the legal liabilities of the business trickle down to the owner.
The immediate positive implication of being a sole owner is that the proprietor gets to enjoy all the profits made by the company. Conversely, it also implies that the owner has to bear the full burden of all the losses incurred by the business. In the case of Joe, as a sole owner he had the right to pocket all the money he obtained as a pre-payment to demolish a house located at 1200 Serenity Lane. However, when he proceeded to demolish a wrong house located at 1234 in the same lane, he fell into a legal problem that will require him to pay an amount equal to the value of the house.
Ambiguous Tax Burden
For corporations and LLCs, the schedule for paying taxes is separable from their owners because these organizations are considered as tax entities. On the contrary, a sole proprietorship is never considered as a tax entity since it has a similar legal identity with the owner (Bull & Burnham, 2008). Therefore, for an organization like that of Joe to be tax compliant, the owner must pay the required taxes personally in form of self-employment tax. Under this form of taxation, a person is required to self-report his or her income to the Internal Revenue Service (IRS).
There are very many legal problems that may arise out of self-reporting. The leading one is the possibility of tax misreporting. For example, in 2015 the IRS released a memo warning about the possibility of imposing penalties on people who underreport their income (Service, 2015). Most proprietors like Joe undertake their activities in the informal sector, and this makes it hard for them to keep accurate records of their profits or losses. For instance, Joe deposited his first earnings in his personal account. Thus, it will be difficult for him to know his actual profits since the account is not an official account where all transactions are accounted for. Eventually, when remitting tax he may unknowingly commit the offense of tax underpayment by reporting false information to the IRS.
Lack of a Comprehensive Insurance Cover
Legally, all businesses are required to have an insurance cover to safeguard their workers and activities. The possibility of unprecedented dangers happening to a business makes it necessary to have an insurance policy. Having a cover gives the proprietor confidence to carry out daily activities because it provides an assurance of alleviating the burden of compensation that may arise from unforeseen accidents or debts. Thus, most business people who think they will be undertaking risky ventures tend to insure their activities in advance to avoid unnecessary law suits that may eventually require them to pay huge amounts of money as reimbursement (Kaplan & Mikes, 2012). Others prefer to avoid sole proprietorships so that they can have a limited liability.
Joe’s business lacks a comprehensive insurance cover that can help him compensate the house owner. Moreover, he is a sole proprietor who cannot be able to limit his liability. Therefore, in case the house owner decides to sue him for compensation, he will ultimately have a legal problem of having to compensate the house owner using his own finances or assets. Joe could have easily avoided this legal eventuality if initially he had taken enough time to form a different form of business, most probably a LLC or a partnership.
Bull, N., & Burnham, P. (2008). Taxation of capital and labor: The diverse landscape by entity type. National Tax Journal, 397-419.
Cole, R. A. (2011, January). How do firms choose legal form of organization?. In ICSB World Conference Proceedings (p. 0_1). International Council for Small business (ICSB).
Kaplan, R. S., & Mikes, A. (2012). Managing risks: a new framework. Harvard Business Review, 90(6).
Longnecker, J. G., Petty, W. J., Palich, L. E., & Moore, C. W. (2010). Small business management: Launching & growing entrepreneurial ventures.Mason, OH, South-Western Cengage Learning.
Service, I. R. (2015). Tax guide for small business. Department of the treasury. IRS.
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