The LLC vs. Sole Proprietorship debate is not going away anytime soon, and for a good reason.
LLCs offer an extra layer of protection against liability and other issues, but they also come with a higher cost to set up.
Sole proprietorships are cheaper to maintain, but nothing is protecting the individual if something goes wrong. So which should you choose? Here are some things to consider before making your decision!
What Is a Limited Liability Company?
LLC business structure offers its members protection from the LLC's debts, obligations, and other liabilities.
LLCs limit each member's personal liability for LLC debts to the amount they contributed or agreed to contribute in their operating agreement.
LLCs are very popular among small businesses because LLC members can avoid double taxation and enjoy tax advantages.
What Is a Sole Proprietorship?
A sole proprietorship is a type of business structure owned by one person and does not have a legal distinction between the LLC's members or managers.
Sole proprietorships have the benefits of an LLC without any extra-legal and tax complexities.
However, sole proprietorships do not offer members protection from personal liability for business obligations or debts since there is no distinction between the individual member and LLC itself.
Filing Procedure: LLC vs. Sole Proprietorship
Both LLC and sole proprietorships need to file specific filing procedures. However, the procedures that LLCs and sole proprietorships follow have differences.
Both LLCs and sole proprietorships need a name to distinguish themselves from other LLCs or sole proprietorships.
LLC members can use the LLC name as their business name, but they need to first register it with state authorities.
On the other hand, sole proprietorships can use their individual names as their business names if they so choose.
However, LLCs and sole proprietorships need to ensure that their respective businesses are not too similar to one another.
If there's a chance of confusion between an LLC or sole proprietorship with another LLC or sole proprietorship in your area, we advise rebranding your business.
It's important to note LLC and sole proprietorship names should be different from the personal name of LLC members or partners, but they can still contain LLC members or partners' initials if desired.
Sole proprietors can opt for "DBA" (Doing Business As). DBA is a phrase that informs customers and creditors about who owns or operates the business.
Articles of Organization
LLCs are required to file articles of organization with the state's LLC filing office.
Articles of Organization file contains basic information about your business, such as name and address and the type of LLC you want to form (member-managed or manager-managed).
If desired, sole proprietorships only need a DBA and any required licenses and/or permits to start operating.
Registered Agent Service
A registered agent is someone responsible for receiving legal documents on behalf of a company.
LLCs file their annual reports with the state's registered agent service and can submit any other required tax filings through them as well.
A sole proprietor doesn't need to file or pay any taxes since sole proprietorship owners are taxed directly by the federal and state governments.
An operating agreement is an agreement between the business members that sets forth the terms and conditions of their business relationship.
Sole proprietorships don't need operating agreements since the law doesn't require them.
However, it's recommended to file one with your DBA if desired to avoid any future disputes within your business's structure or membership status if your business structure requires different levels of the decision-making process.
On the other hand, an LLC operating agreement is highly recommended, even if you're a single-member LLC.
The operating agreement specifies how business expenses are allocated and other important decisions made within the LLC.
It also prevents future disputes between members, such as the distribution of business profits or losses if one member leaves the company unexpectedly.
An employer Identification Number (EIN) is a federal identification number that is given to all business entities.
Sole proprietorships file their taxes using a Social Security Number or a Federal Tax Identification Number, depending on the type of business income they have received throughout the year, so they don't really need an EIN.
LLC members file their own personal tax returns and LLC annual report through EIN issued by the Internal revenue Service.
They file their personal income tax returns using EIN.
Business Structure: Sole Proprietorship vs. LLC
A limited liability company or LLC is separate from its owners. The business has a separate tax status.
You cannot use the company's assets to pay off debts incurred by the business owner or other members, unlike in a sole proprietorship where all personal property is liable for business debt.
This structure offers some personal liability protection because owners (members) have limited liabilities similar to shareholders of a corporation.
LLCs can be member-managed or manager-managed. LLC members run a member-managed LLC, which contributes capital and labor.
Manager-managed LLCs have managers that make company decisions separate from the membership.
A sole proprietorship has only one owner (or a married couple) who owns all or most of the business or the owner's personal assets.
That means that sole proprietors don't have the personal liability protection that LLCs have. Any personal assets can be used if you owe money on business debts or get sued.
Management: Sole Proprietorship vs. LLC
The management structures of a sole proprietorship and an LLC are very different.
A business with separate owners is managed by the members, while a single owner manages his or her own independent business entity.
When deciding between a sole proprietorship vs. LLC, the first thing to consider is how you want to set up your company structure.
A separate business entity is separated from its owner, and a group of managers runs the company.
A sole proprietorship can be more flexible in management structure because there are no formalities required for setting up this type of business entity.
However, an LLC requires that you create articles of organization to set up your separate business entity formally and informally.
Taxes and Fees: Sole Proprietorship vs. LLC
Sole proprietors and LLCs pay taxes in different ways. However, their tax rates are the same as individual taxpayers': they pay income taxes and payroll taxes on their business earnings.
Sole proprietorships file a personal tax return each year. LLCs may choose how they want to be taxed—they can either use pass-through taxation or file a corporate tax return.
Pass-through taxation means that business income is passed through to the owner's personal tax return form.
It becomes part of his/her taxable income (this can be advantageous because the rates for individual taxpayers are lower than those for corporations).
LLCs may also choose to file as an S corporation or a C corporation. However, this varies by state, and not all states allow LLCs to choose how they want to be taxed (however, most states do make an option for pass-through taxation).
A business owner who opts for a sole proprietorship has to pay payroll taxes on the wages he/she pays in addition to income tax. These are their self-employment taxes.
What Are the Advantages of an LLC vs Sole Proprietorship?
Legal protection is one of the primary reasons for forming an LLC. The company structure provides personal liability protection in case your business gets sued.
A tax advantage of an LLC is the pass-through taxation, where business profits are taxed only once.
As a sole proprietor, you would have to pay taxes on your personal tax return for any revenue that is not reported to your payroll account.
Thus, it's in your best interest to form an LLC and let them handle all the accounting, payroll, and tax requirements.
Another benefit of an LLC is its flexibility in operation. Depending on the state, you can choose whether or not to require formal meetings for your company's decision-making process.
Additionally, if there are multiple owners, they don't have to be members at all times, unlike sole proprietorships, requiring full-time interest from the owner.
What Are the Disadvantages of an LLC vs. A Sole Proprietorship?
The biggest disadvantage of an LLC vs. a sole proprietorship is payroll taxes. These payroll tax rates are typically much higher than the personal income tax rate of sole-proprietorship owners.
This can be a serious disadvantage for business owners who want to keep their payroll costs down.
You may be required to pay State Business Taxes and Unemployment Taxes in addition to personal federal, state, local, and self-employed FICA payments.
The cost of filing an LLC's tax return may be higher than that of sole proprietorships.
Who Should Choose an LLC?
Small business owners who want personal liability protection and have multiple employees should choose an LLC.
Businesses with multiple employees should choose an LLC structure, as they must pay more payroll taxes over a sole proprietorship's income tax costs.
Who Should Choose a Sole Proprietorship?
Small business owners who want to pay payroll taxes on their personal tax returns and avoid double taxation of profits should choose a sole proprietorship or corporate taxation.
Sole proprietorships are ideal for many business owners who are new to the business and want to find the right structure for their business that is also cost-effective.
Does LLC Protect Personal Assets?
As an LLC owner, you are not personally liable for any debts the business incurs.
This means that if your LLC is sued, only your assets associated with your company are up for grabs to pay off creditors or plaintiffs in a lawsuit.
As an owner of a sole proprietorship, you and your personal assets are both on the line when it comes to lawsuits involving just your business.
If someone sues your company, the court can order you to sell off personal assets (like your house or car) to raise money for a judgment.
That means that LLC offers personal liability protection and sole proprietorship doesn't.
As a separate legal entity, LLC shields your personal assets from creditors and third parties.
Does a Sole Proprietorship Have Limited Liability?
Sole proprietorships do not offer personal liability protection.
As a sole proprietor, if you are sued, or your business is found liable for damages caused to another party, you are personally liable and forced to pay the debt out of personal assets (like your car).
Is a Single-Member LLC the Same as a Sole Proprietorship?
Single-member LLCs bear very little difference from sole proprietorships to some extent.
The IRS taxes both the same way, which means that the taxes flow directly to the LLC owners, just like they do with sole proprietors.
However, LLC owners can choose to be taxed as an S corporation while sole proprietorships can't.
When Should a Sole Proprietor Become an LLC?
Once your new business has taken off the ground, you should seriously consider becoming an LLC for tax purposes.
As a sole proprietorship, your business is taxed as part of your personal tax return, and that can be complicated to keep track of all the numbers each tax season.
As an LLC, taxes are filed separately from your individual tax returns, making it easier to manage accounting and income at tax time.
Personal liability protection is also a key benefit of forming an LLC.
As a sole proprietorship, you are personally liable for business debts and lawsuits against your company.
An LLC, on the other hand, protects personal assets while still protecting tax benefits.
Can an LLC File as a Sole Proprietorship?
An LLC can't file as a sole proprietorship.
Although an LLC can not be a sole proprietorship, an individual may conduct business as an LLC.
A sole proprietorship is a form of company in which you own and manage your own firm, but it is not a corporation.
A limited liability company is a type of legal formal business structure that is neither a corporation nor a sole proprietorship.
You may have heard that an LLC is better for business than a sole proprietorship, but in reality, this depends on the type of company.
It's best to check everything carefully and make a well-informed decision.
If you are considering starting an LLC or expanding it with more employees, take some time now to research all of the benefits and drawbacks so you can decide what will work best for you before jumping into anything blindly.