Pros and Cons of Sole Proprietorship vs LLC: Everything You Need to Know

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What Are the Pros and Cons of Sole Proprietorship vs. LLC?

There are many pros and cons of sole proprietorship vs. LLC. But before choosing which type of business to form, you should know what each one is.

An LLC, or limited liability company, operates as a hybrid of the partnership and corporate business structures, particularly due to the limited liability protection it offers and pass-through taxation benefits. The LLC is a separate and distinct entity from its owners. It can operate as either a manager-managed or member-managed LLC. This means the members (owners) of the LLC will manage the business. However, the members might choose to hire a manager to oversee the business operations.

A sole proprietorship is the simplest type of business to create. It involves only one member who creates the business and reports all profits and losses on his or her own personal income tax return. Generally, a sole proprietorship doesn’t have any employees. There isn’t any formal action needed to form your sole proprietorship. For example, someone who offers resume review services is considered a sole proprietor.

While there are advantages to both types of business structures, some businesses would be better off creating one type of business over the other, depending on the number of owners, objectives, and overall goals for the business.

Pros vs. Cons of the Sole Proprietorship and LLC

It’s important to understand the pros and cons of operating a sole proprietorship and LLC. Below are some factors to consider when determining which structure is better for your business.

  • Complexityof forming your business
  • Cost of forming your business
  • Taxes

Complexity

The sole proprietorship is the easiest type of business to form. There is far less paperwork when forming it. You really only need to begin doing business and ensure that you have obtained any applicable licenses and permits beforehand.

However, the LLC must take some additional steps before transacting business. Some of these steps include choosing a name for your business, hiring a registered agent, filing the Articles of Organization (and paying a filing fee), drafting an Operating Agreement, obtaining an EIN, and obtaining insurance.

Cost

Other than the fees required for obtaining licensing and permits, the sole proprietorship is nearly free to form since no other costs are required. This type of business structure doesn’t have any formal ongoing requirements, not even so much as a written agreement.

However, with that said, every business needs money to begin doing business. In a sole proprietorship, you will need to fund your own business by obtaining loans or using your own assets. And obtaining a loan for a sole proprietorship could prove challenging, as a lot of financial institutions are hesitant to provide a loan to a sole proprietor as opposed to an LLC, partnership, or corporation. Often, sole proprietors have to personally guarantee a loan given to the business, which could, in turn, cause personal liability if the business is sued.

An LLC has additional ways to raise capital, including adding new members who can bring their own capital contributions and creating new classes of membership interests.

Taxes

A sole proprietor is taxed on all business profits. Therefore, the profits flow through to the owner. However, a single-member LLC might also be taxed in this manner since such businesses are considered disregarded entities by the IRS. Therefore, if the single-member LLC doesn’t elect taxation as a corporation, it will then be treated as a sole proprietorship. While such taxes are passed onto the owners of sole proprietorships and single-member LLCs, those owners can take advantage of the tax deductions for the business.

Furthermore, both business structures can potentially qualify for the pass-through deduction of up to 20 percent of all business income. This is a new deduction that took effect in 2018 under the Tax Cuts and Jobs Act.

If you operate as a sole proprietorship, you will be taxed as a self-employed individual. This means the income from your business is considered personal income. An LLC, however, can be taxed as a sole proprietorship, partnership, or corporation. But the LLC will need to make the election. As previously noted, if the election isn’t made, you risk being treated as a sole proprietorship (single-member LLC) or partnership (multi-member LLCs).

If you need help determining whether you should form a sole proprietorship or LLC, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.


— Update: 05-01-2023 — cohaitungchi.com found an additional article Sole Proprietorship vs. LLC: How to Make the Right Choice for Your Business from the website www.nav.com for the keyword benefits of llc vs sole proprietorship.

The decision to incorporate or not incorporate your business can be a very important choice. While most businesses operate as sole proprietorship, a formal business structure such as an LLC can provide significant benefits including asset protection and greater access to small business financing. Learn more about an LLC vs. a sole prop in this article from Nav’s experts.

Limited Liability Company vs. a Sole Proprietorship

One of the key benefits of a limited liability company (LLC) versus the sole proprietorship is that a member’s liability is limited to the amount of their investment in the LLC. Therefore, a member is not personally liable for the debts of the LLC. A sole proprietor would be liable for the debts incurred by the business. This liability, however, is dependent upon following the rules associated with an LLC. If you treat the LLC the way you would a sole proprietorship, you lose the liability protections.

For example, creditors can go after a sole proprietor’s home, car, and other personal property to satisfy debts, while an LLC that is properly maintained can protect the owner’s personal assets.

What Is a Sole Proprietorship?

When a business operates as a sole proprietorship, it simply starts doing business without forming a separate legal entity. This is the most common business structure used by small business owners in the U.S. It is also the most risky. Here are some key takeaways to think about when considering a sole proprietorship:

  • No required paperwork apart from industry-specific licenses 
  • No annual state filings
  • Simplified tax filing
  • No liability protection
  • Difficult to obtain financing in the business name
  • Harder to build business credit

Advantages of a Sole Proprietorship

When you form a sole proprietorship, you have the following benefits:

Disadvantages of a Sole Proprietorship

However, with a Sole Proprietorship, you also have the following drawbacks:

What Is an LLC?

An LLC, or limited liability company, is a legal business structure for operating a business. It is popular with many business owners due to the ease of setting it up, the fact that it is often cost effective and easier to maintain than other business structures such as S corps or C corps, and because it can provide asset protection. Here are some key takeaways to consider when forming an LLC:

  • More market credibility
  • Liability protection in the case of certain lawsuits and commercial debts
  • More financing options
  • Some paperwork
  • Annual state filings
  • Tax advantages and disadvantages

The Pros & Cons of Forming an LLC

Choosing to form an LLC brings both advantages and additional costs. It will be up to you to weigh the costs against the benefits, however, for serious business owners, it is often well worth it.

Advantages of Forming an LLC

When you form an LLC, you are creating a business entity separate from yourself. In other words, you are not your LLC and your LLC is not you. With the LLC, you will have the following benefits:

Disadvantages of Forming an LLC

With an LLC, you have the following drawbacks as well:

The Difference Between an LLC and a Sole Proprietorship

Forming a sole proprietorship vs. LLC

Let’s look at the distinctions of creating an LLC vs. a self-employed business. Forming a sole proprietorship can be as simple as getting to work. Depending on what kind of work you do, you may have to obtain licenses, permits, zoning clearances, or other permissions from your local government. If you so desire, you can form a legal entity and file an assumed business name, and to make tax season more bearable, obtain an EIN (employer identification number). 

Forming an LLC is a little more involved, but still a relatively simple process. You’ll need to choose a legal name your LLC, and be sure to check your proposed name before going to file; you’ll want to be sure you’re choosing a name unique to your business and and check with an attorney before using a name others have protected with a trademark. You’ll also need to choose a registered agent. This could be yourself if you’re a single-member LLC, or one of your business partners in the case of a multi-member LLC. 

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You’ll then need to file articles of incorporation (the specific name of this document can vary depending on your locale) and create an operating agreement, as well as paying a filing fee. Having a business plan in place can make aspects of this step much simpler as you form an LLC. In some states, you’ll be required to obtain your EIN for tax purposes. 

Financing a sole proprietorship vs. LLC

Whatever type of legal entity you choose to file, funding will likely be a hot topic and a challenge. Experienced small business owners will likely suggest you keep your full-time job while you get your business off the ground; this personal income can be a steady stream of capital as you get your operation moving. Either way, get a business bank account and a business credit card if possible.

Getting a startup loan can be difficult for a new business, but there are other funding opportunities available. You can consider crowdfunding where you can offer donors a gift for their contribution, make them shareholders, or just rely on the goodness of their heart. There are also a number of non-profit lenders offering microloans for new or disadvantaged businesses.

Which pays less taxes, sole proprietorship or LLC?

With both an LLC and a sole proprietorship, the profit of the business passes through to the owner’s personal tax return. But LLCs have more flexibility in how they are taxed, which may result in tax savings.

Sole proprietors typically report their business income and expenses on Schedule C. This form is filed with the owner’s personal tax return. The net profit from the business (line 31 on Schedule C) indicates the net profit of the business and it passes through to the owner’s personal tax return. 

Pass through entities like LLCs and sole proprietorships may benefit from the Qualified Business Income (QBI) deduction that allows them to deduct 20% of QBI. Not all business income (and not all types of small businesses) qualify, so talk with a tax professional.

Is a single-member LLC the same as a sole proprietorship?

Single-member LLCs are automatically treated as sole proprietors for tax purposes, but may elect to be taxed as an S Corporation or C Corporation. This may provide tax savings but will also carry additional requirements. Check with your tax professional to choose the right filing status for your business.

Don’t forget about self-employment tax! The current self-employment tax rate (SECA, instead of FICA) is 15.3%. Normally this is split between the employer and the employee, but when you are the employer you pay the full amount yourself. (There may be ways to reduce self employment tax for LLCs that elect to be taxed as an S Corp.)

Whichever method you choose, keeping good documentation and staying on top of bookkeeping is essential. Keep good records of both income and expenses and work with an experienced bookkeeper or accountant, at least to set things up properly even if you decide to do your own bookkeeping or taxes.

Personal liability protection

Many business owners opt for LLCs because there is no personal liability and have better protections in place for their assets. However, the personal liability protection is not always absolute, so here are things you can do to stay protected:

  • Get LLC Insurance
  • Establish business credit without a personal guarantee
  • Keep business finances and personal finances separate

Sole proprietorships are known for their lack of legal protection, but people who are worried about liability can take the necessary steps to stay protected. Because of the lack of personal protection, the best way to protect yourself is to convert your business into a single-member LLC.

When should a sole proprietor become an LLC?

The decision is ultimately yours. But keep in mind that as a new business, legal protection can be important to your well-being and the longevity of your endeavor. Forming an LLC early on can help protect you personally from business liability. It can also make your business appear more stable to lenders and vendors, as well as customers and business partners. In that sense, it can be an investment in your success. 

Running a sole prop is as simple as getting to work and tracking your income and keeping it separate. You are the owner and the business, so all decisions are yours to make. That makes it easy to get started, but as your business grows you take on more risk.

Is an LLC Always the Best Choice?

Life is all about making choices and choosing to be an LLC owner can be a very important one. Asset protection consultants routinely market to business owners stating that an LLC is “always a good idea,” but I do not believe this to be true. Some entities are actually better suited for a sole proprietorship as the additional costs of an LLC do not provide any significant benefits over operating as a sole proprietor.

Also, understand that with the concept of an LLC providing “liability protection against commercial acts of your business,” a savvy attorney is going to try to find any loophole he can in your current setup to “pierce the corporate veil” and go after personal assets. 

In addition, some courts may not look favorably upon sole member LLCs, and the question comes up in legal proceedings as to whose interests are you being protected against if technically, you are the only member of the LLC.

How Management Structures Differ

At a sole proprietorship, the company owner can make any business decisions without additional input, permission, or legal documents. Sole proprietorships are known to have a simpler structure of management because there’s only one person at the head of the business. As a sole proprietor you only have to make sure that your business is operating legally and safely, and to create a profit margin to reduce business debts.

LLCs can be more complex in terms of the management structures of your type of business. An LLC can be managed by the members or by a manager that’s specifically appointed. Anyone can find that structure in an LLC operating agreement. Not all states require an operating agreement for an LLC, but most businesses operating under them have one — especially with multiple members. An operating agreement details each member’s profit share, voting rights, and stake in the business. 

Mixing Business Funds and Personal Funds

For many businesses, starting off can be quite a task of all the information needed just to get running, leaving other areas vulnerable to mishaps. One mishap entrepreneurs can make is mixing business and personal funds. Typically, this is through storing funds within one account which can create a headache when you file taxes, deter investors looking for the business’s financial discipline, and risk accumulating personal versus business debt.

The best way to start an LLC or sole proprietorship is to get a separate business checking account or an additional account that separates business and personal funds. 

Which Is Better: LLC or Sole Proprietorship?

As with so many questions like this, the answer is: it depends. While obtaining funding or financing can be challenging for any business, the advantages and protections you can enjoy with an LLC can’t be understated. 

Keep in mind your business goals and what you want to achieve. Don’t be scared to get advice or help from seasoned professionals.

FAQs on Sole Proprietorship vs. Limited Liability Company (LLC)

  • Is an LLC better for taxes?

  • Can you convert a sole proprietorship to an LLC?

  • What’s the best state to open an LLC?

  • Do banks prefer LLCs?

If you’re looking for business financing, including small business loans or business credit cards, Nav can help. Using your business credit scores, annual revenue, and other business data, we find the financing you’re most likely to qualify for. Plus you can find tools to help you improve your financial health, like our Cash Flow tool. Use Nav to start seeing your best options today.


— Update: 07-01-2023 — cohaitungchi.com found an additional article Sole Proprietorship vs. Limited Liability Company (LLC): Advantages of Each from the website aofund.org for the keyword benefits of llc vs sole proprietorship.

As a solopreneur, you might be wondering about the most advantageous way to establish your business. As a solo business owner, your best options—at least in the early stages of establishing your business when you are operating alone—are likely between registering your business as a sole proprietorship or as a limited liability company (LLC). Which is more advantageous: a sole proprietorship vs. LLC? It will depend on your needs as a business owner. We will review the advantages and disadvantages of each. But first, let’s define the two and see what the main differences are for a Sole Proprietorship and LLC.

What are the main differences between an LLC and a sole proprietorship?

While it’s perfectly suitable for an LLC to have a single owner, it could also have multiple owners. An LLC is considered a separate legal entity from its owner or owners, which are referred to as “members” of the LLC. The LLC’s members are not held personally liable for business debts or other liabilities incurred by the business, such as lawsuits, accidents, or injuries. Instead, the LLC is responsible.

A sole proprietorship, on the other hand, is always owned and operated by only one person. The owner of the sole proprietorship is entitled to all the profits of the business but is also responsible for all of the business’s debts and liabilities.

LLC Advantages Over Sole Proprietorship

Whether you decide to register your business as a sole proprietorship or an LLC will vary depending on your personal business goals and concerns.

The single biggest advantage of an LLC over a sole proprietorship is personal liability protection. If you register your business as an LLC, your personal assets—such as your home, car, and personal financial accounts—are protected from business debt collection or, in the case that your business is sued, you are personally financially protected against legal claims against your LLC.

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A sole proprietorship offers no such protection as there is no legal separation between you and the business. The debts and obligations of the business belong to your personally. If your business is sued or there are collections actions taken against your business, you personally will be on the hook to pay back the debt or to settle the legal claims against your business. You could also be held personally responsible for liabilities caused by your employees.

Sole Proprietorship Advantages Over an LLC

In a nutshell, starting a sole proprietorship is simpler, less expensive, and less complicated than starting an LLC. One simplification that sole proprietorship offers is that you don’t need to separate your business and personal finances by keeping separate bank accounts. If you plan on taking tax deductions based on business expenses, it might be easier to keep your finances separate for tracking purposes, but you are not required to do so by law. You do, however, need to keep accurate financial records for your business, including business income and expenses, in case you are audited by the IRS.

With an LLC on the other hand, by law you must keep separate accounts for business and personal in order to maintain LLC status and the personal liability protection that it affords you. If you mingle your business and personal accounts, then you could lose your limited liability protection. If debt collection or a lawsuit lands you in court, a judge could rule your LLC null and void if you mingle personal and business assets, in which case you lose all liability protection and your personal assets could be used to pay debts or settle legal claims.

Another advantage provided by the simplicity of the sole proprietorship is that you are not required to register your business name if it’s one and the same as your personal name. If you choose a business name other than your personal name, then you should register your Doing Business As (DBA) name with your state.

If you are starting an LLC on the other hand, you must register your LLC with your state no matter what business name you choose. LLC registration does give your business name protection within your state since there cannot be more than one LLC of the same type or industry with the same name. With an LLC, you must also file articles of organization and write an operating agreement to document the rights and duties of the members. A sole proprietorship does not require you to do any of this.

As an LLC, you will also have to pay a filing fee, which varies by state. You may have to pay to renew your LLC periodically, and some states may require annual or periodic reports. A sole proprietorship requires no such filings, which means another point scored by the simplicity of sole proprietorship.

Conclusion

Depending on your needs and comfort as a business owner, whether it’s liability protection or ease and simplicity that you are craving, the choice may be clear as to which type of business structure you should choose. Some business owners get peace of mind knowing they are legally protected from financial claims against the business, while other business owners prefer to keep things fast, easy and simple. It’s up to you to choose what is best for you and your business. You can always change your business structure later should your needs and desires as a business owner change.


— Update: 07-01-2023 — cohaitungchi.com found an additional article Sole Proprietorship Vs. LLC: Here’s What You Need To Know from the website www.forbes.com for the keyword benefits of llc vs sole proprietorship.

When opening up a new small business, setting up an online store or starting a freelance side gig, you’re faced with the question of whether an LLC or sole proprietorship is the right legal formation for you and your needs. These two business models can make a significant difference in how you run your company from a legal, tax and management perspective. Here’s what you need to know about what sole proprietorships and LLCs do and how to choose the best option for your needs.

At a Glance: Sole Proprietorship Vs. LLC

Sole proprietorships and limited liability companies (LLC) are two of the most common business structures for individuals and small businesses. A sole proprietorship is the simplest and requires minimal paperwork. An LLC requires upfront paperwork and costs but could provide your business long-term benefits that make the investment worth it. Legal protection and potential tax advantages are two big factors to consider when choosing between a sole proprietorship and an LLC.

What Is a Sole Proprietorship?

A sole proprietorship is an unincorporated business that’s owned by the individual running it. A sole proprietorship is the default choice for anyone who runs a business but hasn’t set up another formal business structure like an LLC. As a sole proprietor, there’s no separation between your personal and business assets and expenses. You are personally responsible for all your business’s debts and obligations.

A sole proprietorship can only have one owner. If you take on a business partner, your unincorporated business will become a general partnership.

Individuals that do a lot of contractual work, such as freelancers, consultants and personal trainers often choose to file their taxes as sole proprietors. This is the easiest way to go if you’re just starting out or you’re not yet making enough profit to justify the costs of an LLC. However, even if you’ve been in business for decades, a sole proprietorship may still be the best option, depending on the type of business you run. It’s all going to depend on your income, business type and your personal management preferences.

What Is an LLC?

An LLC is a business entity that’s created by filing paperwork with your state. An LLC can have one owner (known as a “member”) or many owners.

Once formed, an LLC has its own legal identity that’s separate from you, the owner. Because of this, a business creditor cannot legally go after your personal assets if your business is sued or unable to pay its debts. Additionally, an LLC’s bankruptcy is considered separate from the owner’s. If you have employees, an LLC can also help shield you from liability for your employees’ actions.

By default, single-member LLCs are taxed in the same way as sole proprietorships. But an LLC can also elect to be taxed as an S Corporation or a C corporation. This tax flexibility allows LLC owners to choose the most cost-effective tax structure for their particular business. For some businesses, the corporate taxation option is a major reason to form an LLC.

When Should You Open an LLC?

There are a few reasons to open up an LLC instead of operating as a sole proprietorship:

  • You want to expand the company to more than one owner in the future, which is easy with an LLC
  • You want to protect your personal assets from potential financial and legal liability
  • You want to take advantage of any applicable local, state or federal tax benefits that come with forming an LLC

In summary, setting up an LLC could position you for growth and protect you from liability. People also consider opening up an LLC when they reach a certain income threshold in their business and the additional fees and paperwork make sense from a tax perspective. This varies by state and the type of business, so it’s a good idea to speak to your accountant and compare the taxes you’ll be paying with each business structure.

Running Your Business as a Sole Proprietorship Vs. LLC

There are a few distinctions in operating a business as a sole proprietorship vs. an LLC. As a sole proprietor, there’s no separation between you and your business. You’re not obligated to separate your personal and business bank accounts and credit cards. However, opening up a different checking account for your business will make it easier to identify business expenses when it comes time to file your taxes.

With an LLC, it’s important to keep your business finances completely separate from your personal ones. You’ll need a business bank account, and you’ll sign documents and contracts on behalf of the business, not as yourself personally. Keeping things separate preserves your liability protection because it shows that the LLC truly has its own separate identity.

Taxwise, an LLC offers more options than a sole proprietorship. All sole proprietors are self-employed. You’ll list your business income and expenses on Schedule C of your personal tax return and you’ll pay personal income tax on your profits. You’ll also be responsible for paying your own Social Security and Medicare taxes, otherwise known as “self-employment taxes.”

Single-member LLC owners are automatically treated like self-employed sole proprietors for tax purposes. But an LLC can also elect to be taxed as a corporation. With corporate taxation, an LLC owner can be an employee of the company rather than being self-employed. Some business owners find that taxation as an S corp saves on self-employment taxes and enables them to put away more for retirement. If your solo business is starting to make a significant profit, talk to an experienced accountant about the best tax status for your company.

Finally, some people choose to open up an LLC because it gives their business a sense of legitimacy. You’d be operating your business as a company, send payments from the company, and your clients will see the “LLC in your company name. With an LLC, you’ll also be able to establish business credit in a way that you couldn’t with a sole proprietorship.

Sole Proprietorship Vs. LLC: Formation and Registration Costs

Whether you choose a sole proprietorship or an LLC, the formation process and its associated costs will largely depend on your state. For a more detailed look at what you can expect on the LLC side, you can check out our guide on the subject. And many of the providers in our best LLC services guide can help you find companies that make the registration process fast and easy no matter what you need.

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Frequently Asked Questions (FAQs)


— Update: 07-01-2023 — cohaitungchi.com found an additional article Sole Proprietorship vs LLC: What’s the Difference? from the website www.collective.com for the keyword benefits of llc vs sole proprietorship.

No matter how much cash you earned this year, being self-employed can be a complicated business. You’re responsible for everything, including the proper way to structure your company. If you call yourself a freelancer or independent contractor, you’re likely already a sole proprietorship. But you may be wondering if you should form a limited liability company (LLC)? And how do you know if you should be a sole proprietorship vs LLC?

Here are the ins and outs of each so you can understand the difference between a sole proprietorship and LLC and decide which is best for you.

LLC vs sole proprietor: The basics

What’s a sole proprietorship?

A sole proprietorship is a one-person business owned by an individual who also handles the operation of the business. For legal and tax purposes, you’re not a separate entity from your business. You are the business. 

Assets owned by the business are also owned by you; the same is true for debts, income, and liabilities. You pay taxes on your business profits at the same time you file your personal taxes, and these profits are reported on your personal income tax return. By default, your business name will be your personal name, unless you use a trade name, which is also known as “doing business as” or a DBA.

If you own a sole proprietorship, you’ll call yourself a “sole proprietor.” Generally, you don’t have to file anything to start a sole proprietorship; it just happens automatically when you make your first business transaction. Some states, cities, or counties may require you to get a business license or permit, but these actions do not determine whether you have a sole proprietorship. 

What’s an LLC?

Where a sole proprietorship has everything commingled between the person and the business, an LLC creates a legal wall of separation between the two. Legally, the LLC is a separate entity. What’s owned and owed by the LLC is owned and owed by the LLC, and not you.

This is an attractive option for anyone looking to protect their personal assets. An LLC can be owned by a single person (which is called a member), but it can have more than one owner as well. 

Pros and cons of a sole proprietorship vs LLC

If you’re a list-maker, get out your pen! Comparing the pros and cons of each is the best way to see which fits your unique business situation.

Pros of an LLC

The words “limited liability” can be very appealing for those who don’t want to mix business and personal. Also, businesses that form an LLC may be considered more professional to investors and potential business partners. Setting up an LLC isn’t terribly difficult, either, compared to some other more complicated business structures.

Cons of an LLC

For those who don’t have extra cash to spend, forming an LLC could cause a budget pinch. That’s not to say that it doesn’t have its value, but a single-person business who isn’t making much profit could find it hard to justify the expense. Also, most states require that LLCs pay an annual or biennial fee to maintain their LLC status. 

There’s also the matter of paperwork, which has to be filed to form the LLC, then maintained every year or two to keep it active. If you’re not a fan of administrative duties, it’s possible to outsource this task for a fee. 

Pros of a sole proprietorship

It doesn’t get easier than a sole proprietorship. Anyone can set one up, simply by doing business. Tax filing can be done on your personal return, with earnings reported on your Schedule C. 

Cons of a sole proprietorship

What it has in simplicity, it lacks in protection. Since you are your business, if your company ends up in a lawsuit or becomes deeply in debt, it’s on you to sort things out. 

For those who need their business and personal finances separated, including owning assets or applying for loans, this isn’t the ideal scenario. It’s also limited to a single owner (or a partnership of spouses, in some states). If you want to bring on part-owners to your venture, be prepared to ditch sole proprietorship status.

LLC vs sole proprietorship tax differences

Choosing to be a sole proprietor vs LLC doesn’t directly have anything to do with taxes. Even if you form an LLC, you’ll continue to pay taxes as a sole proprietorship, where the profits pass through to the owners’ personal income. This is the default tax treatment for single-member LLCs. 

If your LLC has multiple owners, you’ll each pay taxes based on a percentage of ownership. The separation of an LLC from the owner for liability purposes isn’t what determines your tax situation. 

In tax terms, the biggest difference between a sole proprietor and LLC is that an LLC has what’s called tax flexibility. That means you can request to be taxed as an S Corp or C Corp.

There are differences between S Corps and C Corps, especially when it comes to taxes. You can consult with a tax advisor on what’s best for your situation or read our guide to S Corps vs C Corps. 

The most important difference is that C Corps pay corporate income taxes in addition to requiring their owners to pay personal income tax on their salary and corporate distributions; this is called “double-taxation.” S Corp owners only pay personal income tax on their wages and the company profits that are passed through to their personal tax return. 

The bottom line is there’s not a big difference between LLC vs sole proprietorship taxes, unless you elect to have your LLC taxed as a C Corp or S Corp. 

Other frequently asked questions

Still not sure if you should choose an LLC or sole proprietorship? These are some of the additional questions people ask when trying to decide the best path forward. 

I’m not sure how to change from sole proprietor to LLC. What do I need to do?

Since you’re a sole proprietor by default, making the change to LLC requires that you register your business with your state. Each state has a different department handling this, but your state’s small-business office or secretary of state website is a good place to start. Forming an LLC involves a few steps, which vary by location but often include:

  1. Getting an articles of incorporation (sometimes, called articles of organization) template in person or online
  2. Naming your business, including research that verifies no one else is using the same name in your state
  3. Filling out and submitting the articles of organization
  4. Filing any additional state-required paperwork
  5. Creating and maintaining your operating agreement

Other steps might include assigning a registered agent and certifying that you’ll keep your records updated in the future. There are also fees, which range from $100 to thousands. Getting final approval can take weeks or even months, so plan in advance for the process to take its course.

(Note: These steps assume that you are operating legally in your state, or plan to. If your business needs additional licensing, permits, or zoning approval, get those finished in advance of applying for your LLC. Some pieces of the puzzle may be happening at the same time, simply due to the nature of how the government works. Again, your state rep can help you know which order of events to follow, but ensuring your company is legally allowed to operate is essential, especially before you spend all of that money to organize.)

You can also enlist the help of a service that does this work for you, freeing up that research and filing time for more important business matters. 

Can a sole proprietor have employees?

Yes! You can hire one employee or several. Remember that you’re responsible for paying employer payroll taxes, withholding employee payroll taxes, following local labor laws, and paying your workers according to updated worker classification rules. (Knowing if a worker is an independent contractor, like you, or an actual employee isn’t something you want to get wrong.)

LLCs can have employees, too, and will pay them according to the same rules. 

Pro tip: Did you know that employing your own children may have special tax benefits exclusively for sole proprietors? The IRS allows you to hire your own children and write off their wages as a business expense, just like any other employee.  You can also potentially set-up retirement plans for your children to help with your savings goals. 

One additional perk is that you don’t have to pay Social Security or Medicare taxes, just as long as it’s the child of the owner sole proprietorship or the child of both partners for a partnership. The child must also be under 18. This benefit doesn’t apply to corporations or LLCs with corporate tax structures.

Can a sole proprietor be an LLC?

No. While you can operate your business in a very similar manner from one to the other, you can’t be both at the same time. Once a sole proprietor’s business forms an LLC, it’s legally separated from the owner, a truly different entity. 

How about the other way around, is an LLC a sole proprietorship? Yes, but only for tax purposes and only if the LLC hasn’t elected to be taxed as an S Corp or C Corp. When it comes to liability protection, an LLC is not a sole proprietorship. 

Still not sure who would win in the battle of LLC vs sole proprietorship? The final choice is something only you can make. In the end, those who choose an LLC are those who need liability protection or who want to have several owners or partners. Those who pick a sole proprietorship have basic business needs or limited budgets.  

Whatever you choose, the most important step is to weigh the pros and cons of a sole proprietorship vs LLC and choose the one that meets the unique needs of your business.

References

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About the Author: Tung Chi