LLC vs. Sole Proprietorship: How to Choose Which Is Right for Your Business

There are many types of business structures. Which works best for you?

Getty Images/iStockphoto


When starting a small business on your own, choosing a setup — or business structure — can seem daunting. As a business owner, you will most likely first choose whether to run your business as a sole proprietorship or an LLC (limited liability company). Your decision will have consequences not only for your business, but also for your personal finances, taxes and obligations.

If you are a prospective small business owner, you may not know where to start with a business structure. Here’s a guide to help you get started.

LLC vs. Sole Proprietorship

Before making a final decision, be sure to do a thorough research. It’s important to fully understand the difference between an LLC and a sole proprietorship—and what each option has to offer. Let’s start with the LLC.

What is an LLC?

An LLC does exactly what it sounds like: it limits personal liability for business owners. It also separates business from your personal activities.

Many people who start a business create an LLC to protect personal assets such as vehicles, homes and savings from legal or financial problems such as bankruptcy or business debt collectors.

LLCs are governed by the states, mostly through the Secretary of State’s office. You will likely pay an initial filing fee. Fees vary widely from state to state—most between $50 and $150. Some are taller. Many states also require an ongoing compliance fee and/or an annual report or update. You’ll want to research your state’s requirements thoroughly.

LLCs can be owned by many people, companies, other LLCs, or even foreign entities. Most states do not limit the number of LLC owners. Many states also allow single-member LLCs.

What is a Sole Proprietorship?

A sole trader means you work for yourself. You are responsible and liable for the business entity.

This is the easiest type of business to start with the lowest start-up costs. Independent contractors, business owners, and even franchisees can be sole proprietors.

In fact, if you earn income from a sole proprietorship, you may not realize that the IRS considers the job to be sole proprietorship by default.

As a sole proprietor, you are personally responsible for all decisions or risks, including legal compliance, permits, accounts, taxes, debts and contracts.

This is perhaps the biggest difference between a sole proprietorship and an LLC. Unlike a sole proprietorship, an LLC can help you avoid personal legal, tax, and debt problems if you get sued or a debt collector comes after unpaid business bills.

With a sole trader, your business name is automatically the same as your personal name. You can also register a fictitious or business name to distinguish your business from your personal activities. This is known as a DBA, short for “Doing Business As.”

How to choose which is right for you

Much of your choice may depend on the type of business you run. As always, it’s a good idea to consult with an attorney, business consultant, accountant, or professional organization in your field.

Consider your long-term ambitions for the business. Are you planning to add employees and managers, or will you just be managing things long-term?

If you don’t anticipate expanding your business or adding partners, a sole trader may be for you.

An LLC may be a good choice if your business involves legal or financial risks, or if you want liability protection for your personal assets. Research what is required under your state’s rules through your secretary of state’s office. Another good source of information is the US Small Business Administration.

What about taxes?

You do not need to file a separate tax return from your personal return as a sole trader. Technically, a sole proprietorship falls under the IRS’s “pass-through” tax rules. This means that business operations, including profits, go to your personal tax return.

LLCs have more options. You’ll want to take a close look at them.

There are many types of LLCs and the IRS treats some of them differently. For example, the IRS automatically treats LLCs using the same “pass through” rules as sole proprietors. The LLC does not pay taxes on business income. Rather, the members — or owners — pay taxes on their share of the LLC’s business profits.

But LLC owners can also ask to be taxed as a corporation. This can have certain advantages for certain types of business owners, such as the type of retirement savings vehicle you may want to use.

Consult with an accountant, attorney, or financial advisor to see what structure might be right for you and your goals.

Some other factors to consider

Here are some factors to consider before choosing an LLC or sole proprietorship:

Sole trader:

  • This is the easiest and cheapest way to start and run your own business

  • You make all the decisions – and bear all the risk

  • You do not need to register your business separately

  • You only need to file a personal tax return with the IRS

  • You cannot file taxes as a corporation and may miss out on benefits

  • You and your personal assets are not protected from lawsuits or other risks, such as debt collectors, if the business runs into financial trouble

LLC:

  • With an LLC, you can easily add another owner to expand

  • Your personal assets can be protected from financial and legal liability

  • There may be tax benefits compared to a sole trader

  • No need to register a fictitious name – LLCs should have their own

  • There is more paperwork, fees and other potential ongoing costs to stay compliant compared to a sole proprietorship

  • If you want to add owners or members, you will no longer be the sole decision maker

  • An LLC requires its own Tax Identification Number (TIN) and bank account

Can you convert a sole proprietorship to an LLC?

Simply put: yes. You may consider converting if you are concerned about legal exposure or if you want to grow your business beyond a sole proprietorship or partnership.

Leave a Comment

Your email address will not be published.