Sole proprietorship vs. LLC: choosing the ideal structure
- Starting a sole proprietorship is a quick and simple option for solopreneurs or married couples who file taxes jointly
- LLCs protect your personal assets in the face of debt or lawsuits, but you’ll need to pay annual costs
- Since lenders often limit loans to sole proprietors, forming an LLCs can help you access more outside funding for business growth
When you’re starting a new venture, choosing a business structure is one of the first steps to take. Your decision will affect how your company operates as well as how much liability you personally hold. While there are several legal structures to choose from—ranging from C corporations to partnerships—the choice for many aspiring business owners often comes down to two: a sole proprietorship or limited liability company (LLC).
Sole proprietorships and LLCs are particularly well-suited to small businesses and startups because they are simple to launch and maintain over time. However, both have pros and cons that are important to consider before making a final decision. Use this guide to determine which structure is the best for your business.
What is a sole proprietorship?
A sole proprietorship is a type of business structure owned and run by one person. The IRS also allows some married couples to operate as sole proprietors as long as they file income taxes jointly.
As a sole proprietor, you are your business. Even if you operate under a brand name, your company is not considered a separate business entity (i.e., a business that’s legally and financially separate from its owners). This means you’re personally responsible for the actions of your business—including any debts and injuries that occur as a result.
Sole proprietorships do not require any formal legal paperwork to launch. When you start a new business on your own—even if you’re just starting an online store for extra cash—or work with a company as a single contractor, you operate under this legal structure by default.
What is an LLC?
An LLC is a separate legal entity with an unlimited number of owners. If you plan to co-own your business with even one person you aren’t married to, this legal structure is a better fit than a sole proprietorship.
Unlike a sole proprietorship, starting an LLC requires a formal registration process, which your Secretary of State typically manages. Even if you’re ready to launch, you must wait for approval from your designated state agency before you can get taxed as an LLC and reduce personal liability.
Sole proprietorship vs. LLC: Business structure comparison
Once you understand the basics of forming an LLC vs. sole proprietorship, you can compare the two structures in-depth. Here’s how the two legal structures stack up in key areas.
Sole proprietorships: simpler to form
Sole proprietorships are the easiest business structure to form, requiring little time or expertise. Since this structure provides no legal separation from its owner, the government does not require any formal paperwork or registration process to become a sole proprietor.
Depending on your industry, you may still need to obtain business licenses and permits, as well as an Employer Identification Number (EIN) if you plan to have employees.
If you have a very limited budget or want to start your business as soon as possible, a sole proprietorship is a good option.
LLCs: more labor-intensive to form
To form an LLC, you must file a legal document called the Articles of Organization with your designated state agency, which is often a Secretary of State office. LLC filing fees range from $40–$500.
Many state agencies will review your submission within 10 business days, but others may take as long as six weeks. Reducing your state’s usual turnaround will cost an extra $20–$250 in expediting fees.
After receiving your Certificate of Formation, you might still need to complete these steps before you launch:
- Create an operating agreement
- Obtain an EIN
- Create a separate business bank account
Sole proprietorships: operate under your legal name
By default, the name of a sole proprietorship is the owner’s legal name. To operate under any other name, you must complete a Doing Business As (DBA) filing with your state agency. Compared to filing Articles of Organization, filing a DBA is much simpler and cheaper, at just $5–$50 in most states.
LLCs: operate under a brand name
If you have a unique business name in mind, there’s good news for LLC owners: You can register your brand name while filing your Articles of Organization.
Having a brand name with an “LLC” designation at the end of it can give your business more credibility since it means you have official government approval to operate. For example, if you want to start an HVAC business, you might register it as Big City Air & Heating, LLC.
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Sole proprietorships: greater liability
When you operate as a sole proprietor, there’s no way to distinguish between you and your business in the eyes of the law. If your business is in debt, you are in debt. If your business is sued, you are sued. This legal structure puts your personal assets at risk since creditors can go after both business profits and personal assets to satisfy a business debt.
Sole proprietors also put their personal credit scores at risk. If you ever default on a business loan or your business needs to file for bankruptcy, it may affect your ability to get personal loans, buy or rent a house, and reach other financial goals in the future. While liability insurance can help cover the cost of injuries and property damage that occur on your property or that you’re at fault for, you can still be at risk for lawsuits for breach of contract, negligence, and other legal issues.
LLCs: reduced liability
Because LLCs are separate legal entities, LLC owners do not hold personal liability when their businesses are named in lawsuits or take on debt. You can also file for business bankruptcy if your company is failing, even if your personal finances are perfectly fine.
A lack of legal protection might be okay for a low-risk business—for example, a blogger or freelance designer. But it can be dangerous for small business owners who have a direct impact on clients and employees or frequently need to take on loans for big purchases. If you’re running a construction business, where workers are at a higher risk for injury—or if you’re running a spa, in which clients can slip near hot tubs or get burns from chemical peels and laser treatments—opting for an LLC can help protect your personal assets in case of a lawsuit.
Keep in mind: LLC owners can still be held responsible for acts of negligence and fraud in your business, and your personal assets can still be at risk if you offer them as collateral for a loan.
Sole proprietorships: pass-through taxation
The IRS taxes sole proprietorships and single-member LLCs the same way. When you’re running a one-person show, your business is considered a “disregarded entity” by the IRS. As the sole owner of your business, you’ll benefit from pass-through taxation—meaning your business pays no taxes.
When filing your personal tax return, you simply report business income using Schedule C and pay based on your personal income tax rate. You also need to pay self-employment taxes (15.3%) on your total business profits.
LLCs: broader taxation options
Multi-member LLCs also benefit from pass-through taxation, but they are taxed like partnerships (using Form 1065) to allot payments between owners evenly.
Your state, city, or county may impose additional taxes on LLCs. But the perk of choosing an LLC structure is the option to be taxed as an S corporation (as long as you have fewer than 100 owners, all of whom should be based in the U.S.) or C corporation. You’ll need to file Form 2553 to elect to be taxed as an S corp or Form 8832 to be taxed as a C corp.
A corporate tax status gives you the benefit of 100% deductions on donations, employee health insurance costs, and other business expenses. However, if you’re taxed as a C corporation, you must also file business tax returns and pay high corporate tax rates on business income.
Sole proprietorships: doesn’t require ongoing paperwork
Sole proprietors don’t have to take any action to maintain their legal status outside of filing their personal taxes, which account for business income. No ongoing paperwork is needed, so your business can exist for years to come.
LLC: requires annual reports
LLCs in most states need to file annual reports with their state agency (usually your Secretary of State) to comply with ongoing maintenance requirements. This typically costs around $90. Annual reports provide the state, shareholders, and members of the public with information about your board members, financial performance, and other company activities.
LLCs: requires a designated agent
LLCs require some upkeep to maintain their legal status. As designated in your Articles of Organization, the LLC must have a registered agent—as designated in your Articles of Organization—at all times. The business owner might serve in this role or hire a registered agent service (which costs around $100–$300 per year).
This person’s role is ultimately required to ensure your company’s compliance. The agent must be available to receive legal documents—such as summons or lawsuits—at their listed address during standard business hours, year-round. If you need to update your designated agent or make any other changes to your formation documents, you must file Articles of Amendment, which costs $25–$200.
Sole proprietorships: limited access to financing
Sole proprietors are considered high-risk borrowers, which means it’s more difficult to access financing from traditional lenders and investors. With one person as the owner, lenders expect the business to have fewer assets—and when a sole proprietor defaults on a loan or passes away, the loan may be left largely unpaid.
LLCs: more financing opportunities
If you plan to use outside financing to launch or grow your small business, an LLC might be a better fit. While many traditional lenders and investors won’t work with sole proprietors or limit their ability to borrow, LLCs are commonly accepted by most lenders. Since LLCs separate business and personal assets, lenders can easily gauge your company’s likelihood of repayment. Plus, unlike sole proprietorships, LLCs aren’t automatically terminated if the owner dies.
Sole proprietorship vs. LLC: Which structure should you choose?
Sole proprietorships are a great option for business owners who want to launch quickly with limited funds, especially for freelancers or entrepreneurs whose operations pose limited risk to clients and employees. This business structure can eliminate the headache of a formal process and annual paperwork.
However, the cost and time spent running an LLC can be a worthy investment for some business owners, particularly in high-risk industries, such as home services or restaurants. This structure protects the owner’s personal assets, opens up financing opportunities, and provides broader taxation options that can be particularly beneficial as you grow. If an LLC sounds like the right fit for you, learn more about what it takes to register your business and get one step closer to launching.
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