Whether you’re starting a small company, an online store, you may be thinking if an LLC or a sole proprietorship is the better option for you. From a legal, tax, and managerial viewpoint, these two different business structures can make a big difference in how you manage your firm. Here’s all you need to know about Sole Proprietorship Vs LLC, as well as how to choose the best option for your purposes.
As a small business owner, one of the most crucial but possibly confusing decisions you’ll make is choosing a business entity structure. The variations between each sort of company entity can be difficult to appreciate in real-life terms unless you’re a lawyer or a tax lawyer. However, the type of business entity you choose has severe implications, such as how much tax you pay, how much time you have to spend on documentation, and what happens if your firm is challenged.
If you are wondering whether to form a sole proprietorship or a limited liability corporation (LLC). Each type of business has benefits and drawbacks, and the nature of your firm, as well as other personal and professional factors, may influence your decision. When evaluating the advantages and disadvantages of a sole proprietorship vs LLC for an online business, you need to keep the following points in mind.
We’ll discuss why forming an LLC is the best option for most business owners in our Sole Proprietorship vs. LLC guide below. Let’s dive deep to understand the difference between the entities and make the right choice for your startup.
Before we start, here are the top picks for LLC formation services for your startup:
TABLE OF CONTENTS
Sole Proprietorship Vs LLC: Overview
Limited liability companies (LLCs) and sole proprietorships are two of the most common business models for businesses and individuals. A sole proprietorship is the most straightforward and involves the least amount of paperwork. On the other hand, a limited liability company (LLC) needs initial documentation and costs, but it may give long-term benefits to your company that makes the business profitable. When deciding between a sole proprietorship and an LLC, two major elements to consider are legal protection and potential tax benefits.
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What Is A Sole Proprietorship?
A sole proprietorship is a business that is not registered and is owned by the person who runs it. For everyone who runs a business but hasn’t set up another official business structure like an LLC, a sole proprietorship is the default option. There is no difference between your individual and commercial assets and expenses as a sole proprietor. You are individually liable for all debts and obligations incurred by your company. A sole proprietor is liable for all of the company’s risks and debts. As a result, sole proprietorships can only be used for low-risk or low-profit firms.
A sole proprietor is liable for all of the company’s risks and debts. As a result, sole proprietorships can only be used for low-risk or low-profit firms. Self-employed people, advisors, and fitness trainers that perform a lot of contract work generally prefer to pay their tax as sole traders. If you’re just starting a business or don’t make enough money to afford the expenses of an LLC, this is the easiest method. Based on the type of company, a sole proprietorship may be the best option even if you’ve been in business for years. It will all be determined by your income earned, business kind, and decisions for the company.
When Should You Choose Sole Proprietorship?
The simplest option to start a business is as a sole proprietorship, which involves less documentation and legal filings both at the start and on a continuous basis. Here are some benefits of operating your business as a sole proprietor:
- As a sole proprietorship your business becomes a separate legal person which is able to own assets and hold debts which remain separate from your personal liability.
- You can protect your personal assets even if you are personally liable which includes fraud and other illegal acts
- If you are planning to start a one-person business and don’t expect your business to grow then it is the simplest option as there is no legal fillings required.
- Sole proprietorship also works best when your business is entirely self-financed, but there is some risk to lose your money.
Disadvantages Of Sole Proprietorship:
- There is no personal liability protection which means there is a risk of your business sued
- Limited growth potential as whenever business becomes more profitable the risk also increases
- Sole proprietors pay taxes on their profits as well as full FICA taxes, and their taxes rise as their business grows profitable.
What Is An LLC?
A limited liability company (LLC) is a business structure that protects its owners from personal accountability for the firm’s debts or liabilities. Limited liability companies (LLCs) are hybrid businesses that combine the advantages of a corporation with those of a partnership or a single proprietorship.
An LLC has its own legal personality that is distinct from you after it is founded. As a result, if your company is sued or unable to pay its debts, a corporate creditor cannot legally pursue your personal assets. Furthermore, an LLC’s bankruptcy is considered distinct from that of its owners.
Single-member LLCs are taxed the same as sole proprietors by default. An LLC, on the other hand, can choose to be taxed as an S Corporation or a C Corporation. For this tax freedom, LLC owners can choose the most cost-effective taxation system for their company. The corporation taxation option is a primary reason for some businesses to incorporate an LLC.
When Should You Open An LLC?
There are many advantages to forming an LLC rather than operating as a single proprietorship:
- In the future, you’d like to develop the business to provide more than one owner, which is simple with an LLC.
- You wish to safeguard your financial property from financial and legal risk.
- You’d like to enjoy the benefits of any local, state, or federal tax advantages that come with incorporating an LLC.
- An LLC is easier to set up than a corporation and provides more flexibility and protection for its investors.
- LLCs are a hybrid form that has aspects of both a corporation and a partnership.
If you change your business entity from a sole proprietor to an LLC you can:
- Secure your money, vehicle, and property.
- Boost your sense of peace.
- Increase your company’s growth while protecting your privacy.
- Allow for a higher profit margin and faster expansion.
- Boost your credibility
Comparison Between Sole Proprietorship Vs LLC
Basis For Comparison
A single company unit with a single proprietor.
A Limited Liability Company (LLC) is a company run by its members.
To start a sole proprietorship, the owner must ensure that the company's name does not conflict with that of another company in the same area.
To form an LLC, the members must first register with the state.
The owner of a sole proprietorship is responsible for all aspects business. There's also no liability insurance.
Members of an LLC are liable only to the extent of their investments in the company.
Fees for forming
The proprietor does not have to pay anything to start a sole proprietorship.
The cost of forming an LLC ranges from $100 to $800.
The owner's income is taxed in the case of a sole proprietorship. There is no distinction between individual and commercial taxes.
There is only one taxation procedure for LLCs. Taxes are imposed on members at a rate that is reasonable.
Operations and Management
There is only one owner who takes the final decison on all matters.
For an LLC, owners can share decision making and also has the right to appoint a manager who make decisions
There is no paperwork for a sole proprietorship.
There is less paperwork with an LLC.
Key Differences Between Sole Proprietorship Vs LLC
There are some key differences between sole proprietorship Vs LLC if you are starting a new business as both the entities have different requirements and tex treatments. Let’s see below are main factors:
1. Sole Proprietorship Vs LLC : Formation
A sole proprietorship is the most common business entity in the United States since it is the easiest to form. A sole proprietorship is less complicated, less expensive, and requires less paperwork to get started than an LLC. All you have to do now is start doing business and make sure you have all of the necessary licenses and permits, and your new business is up and running. To form an LLC, you must first incorporate and register your business with the appropriate state agency, which is usually the secretary of state’s office. You must design and file articles of incorporation, as well as pay a filing fee, which in certain states can be extremely expensive.
The name of your LLC, the location of its principal office, the names of its owners or members, the expected duration of your LLC, and any other state-mandated information are typically included within your LLC registration. Setting up an LLC takes more time, money, and work upfront than setting up a sole proprietorship, so keep that in mind when considering which entity is ideal for you.
2. Sole Proprietorship Vs LLC: Legal Protection
There is no legal distinction between the business and personal assets in a sole proprietorship. The debts of the firm are personally liable to the owner. If the company becomes insolvent, the sole proprietor is required to file for filing bankruptcy, which will include both personal and commercial debts. A person claiming a sole proprietorship can also identify the proprietor individually in the lawsuit and collect their financial property.
Forming an LLC is one of the most effective strategies to secure your personal assets. Because an LLC is a legally distinct entity from its owner, the owner is not individually responsible for the liabilities of the company. If the company fails, the owners can declare insolvency, which means they won’t be paying their creditors out of cash. A person who sues an LLC can’t sue the proprietors personally, with a few limitations. In the event of deception, incompetence, or personally guaranteed debts, LLC owners can be held personally liable. There is no company framework that provides complete protection for investors from business debts.
3. Sole Proprietorship Vs LLC: Taxation
In terms of taxation, a single-member LLC and a sole proprietorship are similar. Both are pass-through corporations, which means the company does not pay any income tax. The owner files a Schedule C to their personal taxes and reports business income, which is taxed at the owner’s personal tax rate.
Limited liability companies and sole proprietorships may have added tax requirements in addition to income taxes. If you have employees, you must pay payroll taxes regardless of the business form you choose. If you sell taxable products or services, you must additionally collect federal and municipal sales taxes. Furthermore, as a self-employed company owner, you must pay self-employment payments to the Internal Revenue Service.
LLCs are subject to higher taxes in a few local and state governments authorities. This is known as a franchise tax, LLC tax, or corporate tax depending on the state. You’ll also be responsible to pay local and state income taxes, as well as payroll taxes.
Only LLCs can choose corporate tax status: Tax flexibility is a key distinction between LLCs and sole proprietorships. Only LLC owners have authority about how their company is taxed. They can choose to tax the LLC as a pass-through entity or as an S-corporation or C-corporation. The LLC will pay a federal corporate tax rate if it is taxed as a C-corporation.
By choosing corporation tax status, LLCs can often save money. Dividend payments from a corporation are generally expected to be lower than normal business income when the business is taxable as a corporation. In addition, a company’s net profit is not taxed. LLC members, on the other hand, cannot consider earnings as profits and must pay income tax on all company profits, even if they’re not maintained in the firm.
4. Sole Proprietorship Vs LLC: Paperwork And Compliance
The documentation and regulatory procedures are the main distinctions between an LLC and a sole proprietorship. As said before, a sole proprietorship requires a small amount of documentation prior to beginning operations. After that, all a sole owner has to worry about is national, state, and municipal taxes. Moreover, a sole proprietor may also have to update business licenses.
A limited liability company (LLC) has additional compliance requirements. In several states, LLCs must file an annual report after filing their initial articles of organization. A multi-member LLC has even more duties, including establishing an operating agreement, distributing membership units, tracking ownership transactions, and conducting member meetings. Neither of these actions is legally needed, but they are highly suggested for LLCs to protect members’ liability. Moreover, if you want to dissolve an LLC there is some additional paperwork needed.
5. Sole Proprietorship Vs LLC: Operations And Management
A sole proprietorship has a simple and direct operational and management organization. The proprietor is available to create any strategic decisions they choose without the involvement of a third party. Of course, most single owners choose to engage staff, legal experts, accountants, and other professionals to assist with day-to-day operations. A single owner, on either hand, just needs to be sure that their business is running properly and legally, and there is sufficient profit to pay off their debts.
The operational and management structure of an LLC is more complicated, and it’s generally spelled out in the LLC operating agreement. Although only a few states require an operating agreement, most LLCs, especially those with several members, have one. The partnership agreement sets out each member’s share of the company’s equity, right to vote, and revenue split. Moreover, an LLC can be managed by both a member or appointing a manager.
6. Reporting and Meeting Requirements
Although sole proprietorships and LLCs are not forced to maintain board meetings, state law may require them to disclose monthly or quarterly sales. In most states, LLCs are required to submit an annual report and pay a fee. Regardless of the business kind, all other accounting and documentation for your online retail business will remain the same.
7. Other Considerations and Growth
Other factors to consider about when a decision on the right entity for your online business is:
- If you plan to expand your business, hire workers, or recruit investors in the future, an LLC is generally the best option. If you start out as a sole proprietor, you’ll need to change to an LLC if you want to undertake these future actions.
- Clients, suppliers, and creditors may be more trusting of you if you form an LLC.
- Your financial wealth are not at risk if your LLC is sued. In a sole proprietorship, your business obligations and liabilities are treated as individual debts and obligations. Even if you believe your company will never be sued, unless someone is hurt on the premises or if you are suspected of infringement of trademark.
- By forming an LLC, you may protect your company’s name from being taken by another firm. If you own a sole proprietorship, you can register your business with a fake identity (often known as a “doing business as,” or DBA) to secure your company’s name.
- Whenever a limited liability company (LLC) closes, it must inform the state and distribute assets, whereas sole proprietorships need not.
- LLCs must choose a Registered Agent, who is responsible for receiving process service and other official papers on the company’s behalf.
Sole Proprietorship Vs LLC : Which Should You Choose?
Most companies, begin as sole proprietors since it is the easiest method. There is no documentation required at the onset, and there is no significant financial investment, which is appealing to aspiring entrepreneurs, especially those who are exploring a business idea. Sole proprietors also have it simple when it comes to taxes because they don’t have to file a distinct business tax return.
Since a sole proprietorship provides no protection under the law for your personal assets, you risk going bankrupt if your business fails to meet expectations or encounters an unforeseen problem. In the event of company insolvency or lawsuit, LLC owners aren’t individually accountable for the debts of the company.
Furthermore, LLCs provide tax flexibility. Pass-through taxation, which is how sole proprietors are taxed, is used by the majority of LLC owners. However, if electing corporation tax status for your LLC will save you more money, you can do so. The LLC structure is recognized in all 50 states as a way to help small businesses develop. Many factors will influence the appropriate business structure for you, therefore it’s advisable to contact a business lawyer before making this critical decision. An LLC, on the other hand, is often a good choice for a business owner because of the combination of liability protection and tax flexibility.
A sole proprietorship is the most common way for people to start a business. But if you want to expand your business, then LLC formation is the best option. Individuals form LLCs to protect their own assets from liabilities. Liability protection is available in an LLC that is not accessible in a sole proprietorship.
If case you are serious about growing your business and earning your income then it’s time to transfer from a sole proprietorship to an LLC. Both the business entities have advantages and disadvantages and it totally depends on your business needs.
Therefore, before making a final decision, it is always vital to examine what different business types have to offer, as well as seek professional advice from a lawyer or an online legal service.
Have any questions? Feel free to leave them below. We have experts to guide you in these legal matters and help you choose the right entity.
Frequently Asked Questions (FAQs)
1. Is it necessary to register a sole proprietorship?
A Sole Proprietorship is a type of business organization in which a single person manages and operates. It does not, in general, require registration. This type of business can be chosen by anyone who wants to set up a business with a relatively low investment.
2. Is an LLC better for taxes?
An LLC can provide tax benefits that sole proprietors do not have, but any benefits will rely on your individual situation, and this isn’t always the case, especially when considering the costs of running an LLC. The benefits of an LLC for tax purposes are dependent on a number of criteria, including your earnings, expenses, and the type of job you undertake.
3. Can you convert a sole proprietorship to an LLC?
Yes. Since a person runs a business as a sole proprietorship, you can decide to form an LLC later.
4. Does a sole proprietor need an EIN?
Instead of an EIN, a sole proprietor can use his or her Social Security number. If a sole owner hires staff, he or she only requires an EIN.
5. Can a sole proprietor have employees?
Employees can be hired by sole proprietors as long as they have an EIN from the IRS.
6. Do you need an LLC for an online business?
An LLC is not required to operate an online store or business. However, because of the reduced liability, some people may prefer this business structure.
7. How do I form an LLC?
An LLC is formed by submitting documents to your state and spending a filing fee. For information, forms, and instructions specific to your state, go to the website of the secretary of state or other agency in charge of company filings. With the help of an accountant, lawyer, or an online business formation service, you can form an LLC.
8. Is an LLC always the best choice?
Choosing to form an LLC can always be a crucial decision. Because the increased costs of an LLC do not provide any major benefits above operating as a sole proprietor, certain companies are really best suited for a single proprietorship. Moreover, an LLC provides liability protection against commercial acts of your business.