Sole Proprietorship vs LLC

What Is a Sole Proprietorship?

A sole proprietorship is an unincorporated business with a single owner. If you’re working alone, selling something or providing a paid service, but haven’t filed formation documents with your state, you’re a sole proprietor. As a sole proprietor, you can have employees working for you, but you don’t have any business partners. At the end of the day, you are your business. This means that you and your business aren’t legally distinct entities. The good news is that you don’t have to pay to file paperwork with the state. The bad news is that you also get all the risk, all the responsibility, and all the potential losses if your business gets sued or goes bankrupt.

What Is an LLC?

An LLC (limited liability company) is a legal entity created at the state level that is used to own, operate and protect a business and its owners. LLCs are popular business entities because they combine the best aspects of sole proprietorships and partnerships with the legal protections of a corporation. To put it different, forming an LLC allows you to have liability protection without the added hassle of electing a board of directors, issuing stock, and paying corporate taxes.

The Differences Between an LLC and a Sole Proprietorship

Sole proprietorships and LLCs are two of the most popular business types, but they do have their differences—namely, how they’re taxed, managed, and the level of personal asset protection you’ll have. Here’s what you need to know about how sole proprietorships and LLCs operate.

Asset Protection

As a sole proprietor, you are your business. This means that if your business were to go belly up or face a lawsuit, you’d be on the hook to pay. Your personal assets are at stake and could be awarded to the people suing you.

An LLC, on the other hand, is a separate entity from you, the owner. This means that if your business faces a lawsuit, only the assets held by your LLC are at risk—not your personal assets.

Price Tag

Other than the fees for local permits or licenses, sole proprietorships don’t cost anything to start. Forming an LLC can cost a pretty penny. Some states are affordable, like Mississippi, where you’ll pay $50 to register your LLC. And then there’s Massachusetts, where you’ll pay ten times more ($500) to register your LLC. Many states also require you to file additional paperwork once a year or every other year, which also costs money.

Taxation

With a sole proprietorship, you get pass-through taxation. This means that all profits pass through the business and onto your personal tax return. You simply report your profits and losses to the IRS on a Schedule C form and include it with your personal tax return. Can’t get any easier than that.

LLCs are also taxed as pass-through entities by default. However, LLCs have the flexibility to elect to be taxed as an S-Corp or a C-Corp. This allows LLC members to choose the tax structure that best meets their business needs.

Annual Reports and Extra Costs

Sole proprietors don’t have to worry about annual reports or extra state fees. While a Colorado annual report costs just $10, Nevada will hit you for $350. Ouch! Depending on the state, there also may be additional costs for LLCs as well. For instance, there’s a $300 a year tax for LLCs in Delaware. Some states have other costly requirements too. Just look at New York, where LLCs have to publish a notification for their new business in two local newspapers—and the newspapers have steep publishing fees.

Registered Agents

LLCs are required by law to appoint a registered agent, something that sole proprietors don’t have to worry about. Appointing a registered agent for your LLC doesn’t have to come with a price tag. You can act as your own registered agent or appoint another member of the LLC to act as one. However, many LLCs employ a professional registered agent service. While this may seem like an added wrinkle and an extra headache to doing business as an LLC, a registered agent can help keep the private information of LLC members off public records, allowing them to live privately.

Ongoing Paperwork

LLCs usually need to write an operating agreement and update the state if any important information changes. For instance, if you move your LLC’s principal office, you’ll typically have to file a form (and pay a fee) to let your state know of the address change. What if you’ve decided you’ve had enough of being the boss and decide to close the business? In a sole proprietorship, your business ends when you stop working. No paperwork to file, no fees to pay. If you have an LLC, you’ll have to submit paperwork and pay a fee to formally dissolve your business (or else you may continue to accrue fees).

Credibility

Having the “LLC” at the end of your business name will give your business a certain level of prestige. An LLC conveys to your customers that they can trust you, that you’re not just some random person in business with no legal entity to back it up. Likewise, potential investors and clients will be able to see that you are serious about your business. Unless a sole proprietor registers a DBA, they’ll be stuck using their name for the business, and that just doesn’t carry the same weight as a business name followed by an “LLC.”

Privacy

If you’re a sole proprietor, your business name is your name. If you value your privacy, this arrangement doesn’t exactly lend itself to keeping your name out of the public domain. If you’re running a sole proprietorship from home, your home address could be exposed. Yikes! Because LLCs are separate entities from their ownership, they have a much easier time keeping their information private, especially when they hire professional registered agent service. Any good registered agent will help protect your privacy by allowing you to use their address on all of your LLC’s state registration documents, helping to minimize your exposure to prying eyes.

Potential Growth

LLCs are often more appealing to lenders and potential investors because the limited liability protection of the LLC means that investors know that their personal assets aren’t at risk. LLCs can also expand their ownership by bring on additional members to invest in the business. Sole proprietors can only be owned and operated by an individual, and with no liability protection, both banks and investors are shy when it comes to handing out money to grow the business.

When To Turn Your Sole Proprietorship Into an LLC?

For many sole proprietors with growing businesses, forming an LLC is the logical next step. Here are some clues that it may be time to upgrade your business.

You’re Adding a Business Partner

As a sole proprietor, if you bring on a co-owner, your business automatically becomes a general partnership. Adding a second owner to your business will increase your risk. If your new business partner does something wrong while acting on behalf of the business, even if you didn’t authorize it, your assets will still be on the hook for any lawsuit that arises. With an LLC you can bring on as many business partners (members) as you want. Your multi-member LLC will help protect your personal assets and the assets of the LLC members.

You Want More Tax Options

When it comes to taxes, an LLC offers more options than a sole proprietorship. Sole proprietors are self-employed, which means a sole proprietor will pay personal income tax on business profits and self-employment taxes of 15.3%. An LLC often pays taxes in a similar manner, but has the option to elect to be taxed as an S-Corp. With S-Corp taxation, an LLC owner can be an employee of the company, which means they can save on self-employment taxes.

You Plan To Hire Employees

As a sole proprietor, you are personally liable for anything that goes wrong with your business. This means that if one of your employees gets injured on the job or injures a customer, you’ll be held liable. This is why many business owners who plan to hire employees choose to form an LLC, because it protect their personal assets from employee mishaps and disputes.