LLC vs. Sole-Proprietorship

Limited liability companies (LLCs) are business structures in the United States where the owners are is a business structure in the United States. In this business structure, business owners are not personally liable for any of the company's debts or liabilities. This is important when it comes to asset protection, especially if you own a home, or work in a controversial line of business.

Advantages & Disadvantages of LLC

The only disadvantage of an LLC versus a sole proprietorship is that there is some added complexity. This comes with filing fees and the way you elect taxation. Despite this, there are advantages as well and they include:

  • Tax savings can pay for formation costs
  • Liability protection
  • Privacy (if formed anonymously)
  • More professional
  • More tax flexibility

What is a Sole Proprietorship?

Sole proprietorships are also referred to as sole traders or proprietorships. These are always an unincorporated business that has just one owner who pays personal income tax on all profits earned from the business.

Advantages & Disadvantages of Sole Proprietorship

Sole proprietorships do not have the ability to write off as much as businesses such as an LLC. This is because there is a potential to pay more in taxes due to everything being earned income.

There is also an unlimited liability when it comes to a sole proprietorship because there is no protection for personal assets. This is dangerous and means you can be sued for commercial activities, which puts personal assets at risk.

It can also be difficult to grow or raise money as a single person operating in business because sole proprietors are not viewed as being professional as compared to an LLC or corporation. You may be able to secure this from friends and family, but otherwise, an investor will not invest in a sole proprietorship. This could limit the number of funds you have available to grow, develop, and sustain your business.

This carries over into obtaining a business line of credit as well. Most banks and loan companies will categorize your request as a “personal loan” rather than a “business loan”.

What is the difference between an LLC and a sole proprietorship?

Generally, sole proprietors own a small or part-time business. Most often there are no employees and it costs nothing to establish a sole proprietorship. Another form of business entity is an LLC. Unlike a sole proprietorship, an LLC is a hybrid of the partnership and corporate forms. These provide limited liability protection that is offered to a corporation with the tax advantages of a partnership.

How does the startup process differ?

Forming a sole proprietorship is extremely simple. All you need to do is decide the kind of work you want to perform, and then obtain licenses, permits, or other permissions from your local government. If you decide to form as an LLC you will need to form as a legal entity, file an assumed business name, and obtain an EIN (employer identification number).

Forming an LLC is a lot more involved as well. The legal name for the LLC must be unique, and not already used by any other business. You will also need to choose a registered agent who can accept due process on behalf of your business. This could be yourself if you are a single-member LLC, or one of your business partners, or employees. You can also use a third-party company to handle this for you.

Next, you will need to file the articles of incorporation and create an operating agreement. These are essential to do in forming an LLC, along with the filing fee. If you have a business plan in place, then you can obtain an EIN for tax purposes.

LLC & Sole Proprietorship Taxation

If you operate your business as a sole proprietor, then you will automatically be tax as a self-employed person. Similar to an LLC, you will be required to pay self-employment taxes such as Medicare and social security taxes. The income of your business will also be considered your personal income for tax purposes. This is the same with an LLC. Despite this though, an LLC may make an election to be taxed differently.

LLCs can choose to be taxed either as a disregarded entity, partnership, corporation, or s-corp. If this isn’t made, then it is automatically taxed as either a disregarded entity or a partnership, depending on the number of members it has.

Should You Start an LLC or Sole Proprietorship

Forming an LLC is often the best choice. This is because LLCs offer asset protection. Despite this many small businesses are actually better suited for a sole proprietorship due to the costs of the LLC in order to form and operate. In some cases, an LLC does not provide any significant benefits over operating as a sole proprietor.

When it comes to forming a single-member LLC, some states do not take them as seriously. This means that you may not be fully protected in terms of going to court if you are the only member. It is also good to note that the protections afforded for an LLC are wonderful for any growing business. Therefore it comes down to whether or not it is the best option for you and your business. Contacting a lawyer for more information on which one you are best suited for is a great idea.

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