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.

A sole-proprietorship is an unincorporated entity type that is essentially just a sole individual that owns and operates a business. This individual owner will report business profits on their personal tax return and be personally responsible for any business debts.

There are a number of advantages that sole-proprietorships can enjoy. For example, a sole-proprietorship won’t have to fill out formation paperwork with the state or file any annual reports. Note, however, that certain industries might have their own licensing or filing requirements that you’ll want to be sure to follow.

Additionally, all of the profits and losses from your business will be reported on your individual tax return, meaning that you’re responsible for federal, state, local, and FICA taxes but not for any additional business or unemployment taxes. There’s also the possibility that you’ll be able to write off some of your expenses as business expenses.

There are a few notable disadvantages associated with sole-proprietorships, as well, that you should keep in mind. For example, sole-proprietorships do not enjoy the limited liability protection that LLCs offer. This means that you’re vulnerable to lawsuits, commercial debts, and other potential obligations that will put your own personal assets in jeopardy.

Additionally, sole-proprietorships are not likely to attract investors or be able to establish business credit, as financial institutions will approach the request as a personal loan. These factors will limit the growth potential of your business. Also, if you don’t utilize a DBA name for your sole-proprietorship, your business will likely face lower market credibility.

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.

You may have noticed some of the distinctions between LLCs and sole-proprietorships from the characteristics listed above. However, there are a few key differences between the two that are worth highlighting in greater detail.

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 vs Sole-Proprietorship: Formation

When it comes to formation, the simplest option is a sole-proprietorship, as there are no state registration requirements of filing fees of any kind. Note, however, that this is because sole-proprietorships tend to be small operations run by a single person without any employees.

Forming an LLC, on the other hand, requires formal registration at the state level. This process varies some from state to state but typically includes filing articles of organization and paying a filing fee with the Secretary of State’s office or Division of Corporations in your state.

LLC vs Sole-Proprietorship: Asset Protection

When it comes to protecting your personal assets, there is a key difference between LLCs and sole-proprietorships. When formed correctly and kept in good standing with the state, LLCs offer its owners limited liability protection. This means that a member’s liability can only extend to the amount of their investment into the LLC, not to their personal assets.

A sole-proprietorship, on the other hand, is liable for any debts or obligations that might be incurred by the business. In such a scenario, the sole-proprietor’s personal assets could be in jeopardy. Owners of an LLC, however, would not be liable for any such debts.

LLC vs Sole-Proprietorship: Taxation

When it comes to taxes, if your business is a sole-proprietorship then its income is considered personal income and will be reported on your personal tax return.

LLCs, on the other hand, have the option of electing to be taxed as a corporation or to be taxed as a sole-proprietorship or partnership. The latter option is the default classification for LLCs. This means that LLCs enjoy pass-through taxation in the same way that sole-proprietorships do, as profits from the business are reported on the owner(s) personal tax returns.

The main difference between these two when it comes to taxation is the fact that LLCs have the option to be taxed as a corporation, whether a C-corporation or S-corporation, while sole-proprietorships do not have this option.

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.

What Is an LLC?

A limited liability company (LLC) is a business entity type that offers its owners limited liability protection. It is often viewed as a hybrid structure that combines the pass-through taxation benefits of a sole-proprietorship (or partnership) with the liability protection of a corporation.

There are many advantages that your business can enjoy by choosing to form an LLC. Often times the most sought after advantage of an LLC is the liability protection that shields owners from lawsuits and other debt obligations. With a properly formed and maintained LLC, your personal assets will be safe from any potential business liabilities.

Also, LLC owners will find that it’s much simpler to secure equity investment and debt financing with a business entity that is separate and distinct from their personal finances. You’ll have a much easier time establishing credit for your business and find that you have better opportunity for loans, leases, and more. The LLC structure also enjoys a higher market credibility than that of a sole-proprietorship.

As you consider which entity type is right for your business, note that there are a few disadvantages associated with LLCs, as well. There are ongoing administrative matters to handle, such as the paperwork and fees associated with formation and subsequent annual filings. Depending on the nature of your business this can include industry-specific licensing fees.

Which Is Right for Your Business: LLC or Sole-Proprietorship?

When it comes to choosing which entity type is best for your business, the answer should boil down to your specific business goals and priorities. For example, if you run a small operation with very little potential for risk and are not looking to grow your business, you may determine that it’s not worth the additional registration and costs of an LLC.

Keep in mind, however, that few business owners ever regret having liability protection in place. The protections that an LLC can offer you and your business may greatly outweigh the relatively minor cost and effort associated with forming and maintaining your LLC. This protection to your personal assets is something that a sole-proprietorship just simply cannot provide.

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