Here’s What You Need To Know – Forbes Advisor

As a solo business owner, the choice to operate as a sole proprietor or form a limited liability company (LLC) can make a significant difference in how you run your company from a legal, tax and management perspective. Here’s what you need to know to choose whether a sole proprietorship or LLC is the best structure for your business.

What Is a Sole Proprietorship?

A sole proprietorship is an unregistered business that’s owned by the individual running it. A sole proprietorship is the default classification for anyone who runs a business but hasn’t registered it. As a sole proprietor, there’s no separation between your personal and business assets and expenses. You are personally responsible for all your business’s debts and obligations.

A sole proprietorship can only have one owner. If you take on a business partner, your unregistered business will become a general partnership.

Individuals who do a lot of contract work, such as freelancers, consultants and personal trainers, often operate as sole proprietors. This is the easiest way to go when you’re just starting a business or operating as a side gig, but it can be a good fit even for businesses that have been operating for decades.

What Is an LLC?

An LLC is a business entity you create by filing paperwork with your state. It can have one owner (known as a “member”) or many owners.

Once formed, an LLC has its own legal identity that’s separate from you, the owner. Because of this, a business creditor cannot legally go after your personal assets if your business is sued or unable to pay its debts, unless you personally guarantee the debts. Additionally, an LLC’s bankruptcy is considered separate from the owner’s. If you have employees, an LLC can help shield you personally from liability for your employees’ actions.

By default, single-member LLCs are taxed in the same way as sole proprietorships. But an LLC can instead elect to be taxed as an S Corporation or a C corporation. This tax flexibility allows LLC owners to choose the most cost-effective tax structure for their business. For some businesses, the corporate taxation option is a major incentive to form an LLC.

When To Choose an LLC Over a Sole Proprietorship

You might register an LLC instead of operating as a sole proprietorship if:

• You want to expand the company to more than one owner in the future, which is easy with an LLC
• You want to protect your personal assets from potential financial and legal liability
• You want to take advantage of any applicable local, state or federal tax benefits that come with forming an LLC
• You want to hire a third-party registered agent service to field business correspondence for you

Setting up an LLC could position you for growth and protect you from liability. People typically consider starting an LLC when they reach a certain income threshold that incentivizes the S Corp tax benefits. This varies by state and the type of business, so it’s a good idea to speak to your accountant and compare the taxes you’ll be paying with each business structure.

Sole Proprietorship vs. LLC: Running Your Business

There are a few distinctions in operating a business as a sole proprietorship versus an LLC. As a sole proprietor, there’s no separation between you and your business. You’re not obligated to separate your personal and business bank accounts and credit cards. However, opening up a different checking account for your business will make it easier to identify business expenses when it comes time to file your taxes.

With an LLC, it’s important to keep your business finances completely separate from your personal ones. You’ll need a business bank account, and you’ll sign documents and contracts on behalf of the business, not as yourself personally. Keeping things separate preserves your liability protection because it shows the LLC truly has its own separate identity.

Taxwise, an LLC offers more options than a sole proprietorship. Sole proprietors list business income and expenses on Schedule C of a personal tax return and pay personal income tax on profits. You’ll also be responsible for paying your own Social Security and Medicare taxes, otherwise known as “self-employment taxes.”

Single-member LLC owners are treated like sole proprietors for tax purposes by default. But an LLC can instead elect to be taxed as a corporation. With corporate taxation, an LLC owner can be paid as a W-2 employee of the company. Some business owners find taxation as an S corp saves on self-employment taxes and enables them to put away more for retirement. If your solo business makes a significant profit, talk to an accountant about the best tax treatment for your company.

Finally, some people choose to start an LLC because it gives their business a sense of legitimacy. You’d be operating your business as a company, send payments from the company and your clients will see the “LLC” in your company name. With an LLC, you’ll also be able to establish business credit in a way you couldn’t with a sole proprietorship.

Sole Proprietorship vs. LLC: Formation and Registration Costs

You don’t have to register a sole proprietorship with your state, so it doesn’t come with any required formation costs. You might register a DBA (doing business as) or fictitious name to use a business name that’s different from your own, which costs around $10 depending on your state.

When you form an LLC, the formation process and its associated costs depend on your state. For a more detailed look at what you can expect, check out the Forbes Advisor guide to starting an LLC. An online LLC service or local business attorney can offer additional guidance.

Both an LLC and a sole proprietorship are subject to any required business licenses in your area, which might come with an additional cost.

Sole Proprietorship vs. LLC: Which Structure Is Best for Your Business?

Sole proprietorships and limited liability companies (LLC) are two of the most common business structures for individuals and small businesses. A sole proprietorship is the simplest and requires minimal paperwork. An LLC requires upfront paperwork and small costs but could provide your business long-term benefits that make the investment worth it. Legal protection and potential tax advantages are two big factors to consider when choosing between a sole proprietorship and an LLC.