The decision to incorporate or not incorporate your business can be a very important choice. While most businesses operate as sole proprietorship, a formal business structure such as an LLC can provide significant benefits including asset protection and greater access to small business financing. Show
Limited Liability Company Versus a Sole ProprietorshipOne of the key benefits of an LLC versus the sole proprietorship is that a member’s liability is limited to the amount of their investment in the LLC. Therefore, a member is not personally liable for the debts of the LLC. A sole proprietor would be liable for the debts incurred by the business. This liability, however, is dependent upon following the rules associated with an LLC. If you treat the LLC the way you would a sole proprietorship, you lose the liability protections. For example, creditors can go after a sole proprietor’s home, car and other personal property to satisfy debts, while an LLC that is properly maintained can protect the owner’s personal assets. This article does not offer legal or tax advice. Consult your advisors to choose the right business structure for your business.
Compare the Best Business Formation Services Form an LLC, corporation, or nonprofit, and get an EIN, business license, or registered agent service. Use our research to quickly and easily find the right business formation service for you. Compare Now What is a Sole Proprietorship?When a business operates as a sole proprietorship, it simply starts doing business without forming a separate legal entity. This is the most common business structure used by small business owners in the U.S.. It is also the most risky. Here are some key takeaways to think about when considering a sole proprietorship:
Advantages of a Sole ProprietorshipWhen you form a sole proprietorship, you have the following benefits:
Disadvantages of a Sole ProprietorshipHowever, with a Sole Proprietorship, you also have the following drawbacks:
What is an LLC?An LLC, or Limited Liability Company, is a legal business structure for operating a business. It is popular with many business owners due to the ease of setting it up, the fact that it is often cost effective and easier to maintain than other business structures such as S corps or C corps, and because it can provide asset protection. Here are some key takeaways to consider when forming an LLC:
The Pros & Cons of Forming an LLCChoosing to form an LLC brings both advantages and additional costs. It will be up to you to weigh the costs against the benefits, however, for serious business owners, it is often well worth it. Advantages of Forming an LLCWhen you form an LLC, you are creating a business entity separate from yourself. In other words, you are not your LLC and your LLC is not you. With the LLC, you will have the following benefits:
Disadvantages of Forming an LLCWith an LLC, you have the following drawbacks as well:
The Difference Between an LLC and a Sole ProprietorshipForming a Sole Proprietorship vs. LLCForming a sole proprietorship can be as simple as getting to work. Depending on what kind of work you do, you may have to obtain licenses, permits, zoning clearances, or other permissions from your local government. If you so desire, you can form a legal entity and file an assumed business name, and to make tax season more bearable, obtain an EIN (employer identification number). Forming an LLC is a little more involved, but still a relatively simple process. You’ll need to choose a legal name your LLC, and be sure to check your proposed name before going to file; you’ll want to be sure you’re choosing a name unique to your business and and check with an attorney before using a name others have protected with a trademark. You’ll also need to choose a registered agent. This could be yourself if you’re a single-member LLC, or one of your business partners in the case of a multi-member LLC. You’ll then need to file articles of incorporation (the specific name of this document can vary depending on your locale) and create an operating agreement, as well as paying a filing fee. Having a business plan in place can make aspects of this step much simpler as you form an LLC. In some states, you’ll be required to obtain your EIN for tax purposes. Regardless of whether you decide to form an LLC, you should make sure you have the proper business insurance for additional protection and for your peace of mind. Financing a Sole Proprietorship vs LLCWhatever type of legal entity you choose to file, funding will likely be a hot topic and a challenge. Experienced small business owners will likely suggest you keep your full-time job while you get your business off the ground; this personal income can be a steady stream of capital as you get your operation moving. Either way, get a business bank account and a business credit card if possible. Getting a startup loan can be difficult for a new business, but there are other funding opportunities available. You can consider crowdfunding where you can offer donors a gift for their contribution, make them shareholders, or just rely on the goodness of their heart. There are also a number of non-profit lenders offering microloans for new or disadvantaged businesses.
Compare the Best Business Checking Accounts Opening a business checking account can increase your chances of getting financing and simplify your cash flow management. Use our research to quickly and easily find the right account for your business. Compare Now Which Pays Less Taxes, Sole Proprietorship or LLC?With both an LLC and a sole proprietorship, the profit of the business passes through to the owner’s personal tax return. But LLCs have more flexibility in how they are taxed, which may result in tax savings. Sole proprietors typically report their business income and expenses on Schedule C. This form is filed with the owner’s personal tax return. The net profit from the business (line 31 on Schedule C) indicates the net profit of the business and it passes through to the owner’s personal tax return. Pass through entities like LLCs and sole proprietorships may benefit from the Qualified Business Income (QBI) deduction that allows them to deduct 20% of QBI. Not all business income (and not all types of small businesses) qualify, so talk with a tax professional. Is a Single-Member LLC the Same as a Sole Proprietorship?Single-member LLCs are automatically treated as sole proprietors for tax purposes, but may elect to be taxed as an S Corporation or C Corporation. This may provide tax savings but will also carry additional requirements. Check with your tax professional to choose the right filing status for your business. Don’t forget about self-employment tax! The current self-employment tax rate (SECA, instead of FICA) is 15.3%. Normally this is split between the employer and the employee, but when you are the employer you pay the full amount yourself. (There may be ways to reduce self employment tax for LLCs that elect to be taxed as an S Corp.) Whichever method you choose, keeping good documentation and staying on top of bookkeeping is essential. Keep good records of both income and expenses and work with an experienced bookkeeper or accountant, at least to set things up properly even if you decide to do your own bookkeeping or taxes. Personal Liability ProtectionMany business owners opt for LLCs because there is no personal liability and have better protections in place for their assets. However, the personal liability protection is not always absolute, so here are things you can do to stay protected:
Sole proprietorships are known for their lack of legal protection, but people who are worried about liability can take the necessary steps to stay protected. Because of the lack of personal protection, the best way to protect yourself is to convert your business into a single-member LLC. When Should a Sole Proprietor Become an LLC?The decision is ultimately yours. But keep in mind that as a new business, legal protection can be important to your well-being and the longevity of your endeavor. Forming an LLC early on can help protect you personally from business liability. It can also make your business appear more stable to lenders and vendors, as well as customers and business partners. In that sense, it can be an investment in your success. Running a sole prop is as simple as getting to work and tracking your income and keeping it separate. You are the owner and the business, so all decisions are yours to make. That makes it easy to get started, but as your business grows you take on more risk. Is an LLC Always the Best Choice?Life is all about making choices and choosing to form an LLC can be a very important one. Asset protection consultants routinely market to business owners stating that an LLC is always a “good idea”, but I do not believe this to be true. Some entities are actually better suited for a sole proprietorship as the additional costs of an LLC do not provide any significant benefits over operating as a sole proprietor. Also, understand that with the concept of an LLC providing “liability protection against commercial acts of your business”, a savvy attorney is going to try to find any loophole he can in your current setup to “pierce the corporate veil” and go after personal assets. In addition, some courts may not look favorably upon sole member LLCs, and the question comes up in legal proceedings as to whose interests are you being protected against if technically, you are the only member of the LLC. How Management Structures DifferAt a sole proprietorship, the company owner can make any business decisions without additional input, permission, or legal documents. Sole proprietorships are known to have a simpler structure of management because there’s only one person at the head of the business. As a sole proprietor you only have to make sure that your business is operating legally and safely, and to create a profit margin to reduce business debts. LLCs can be more complex in terms of the management structures of your type of business. An LLC can be managed by the members or by a manager that’s specifically appointed. Anyone can find that structure in an LLC operating agreement. Not all states require an operating agreement for an LLC, but most businesses operating under them have one — especially with multiple members. An operating agreement details each member’s profit share, voting rights, and stake in the business. Mixing Business Funds and Personal FundsFor many businesses, starting off can be quite a task of all the information needed just to get running, leaving other areas vulnerable to mishaps. One mishap entrepreneurs can make is mixing business and personal funds. Typically, this is through storing funds within one account which can create a headache when you file taxes, deter investors looking for the business’s financial discipline, and risk accumulating personal versus business debt. The best way to start an LLC or sole proprietorship is to get a separate business checking account or an additional account that separates business and personal funds. Which is Better: LLC or Sole Proprietorship?As with so many questions like this, the answer is: it depends. While obtaining funding or financing can be challenging for any business, the advantages and protections you can enjoy with an LLC can’t be understated. Keep in mind your business goals and what you want to achieve. Don’t be scared to get advice or help from seasoned professionals.
Compare the Best Business Formation Services Form an LLC, corporation, or nonprofit, and get an EIN, business license, or registered agent service. Use our research to quickly and easily find the right business formation service for you. Compare Now This article was originally written on December 3, 2019 and updated on July 19, 2022. Rate This ArticleThis article currently has 584 ratings with an average of 4.5 stars. Whats better a LLC or sole proprietorship?One of the key benefits of an LLC versus the sole proprietorship is that a member's liability is limited to the amount of their investment in the LLC. Therefore, a member is not personally liable for the debts of the LLC. A sole proprietor would be liable for the debts incurred by the business.
Why might someone choose to organize as an LLC instead of a sole proprietorship?LLC is a separate legal entity. Thus, the main advantage of an LLC is that your personal assets are protected. Creditors cannot claim assets that are not owned by the company. Also, you as a partner or owner cannot be sued because of the actions of your employees or your partners.
Is it better to be self employed or LLC?You can't avoid self-employment taxes entirely, but forming a corporation or an LLC could save you thousands of dollars every year. If you form an LLC, people can only sue you for its assets, while your personal assets stay protected. You can have your LLC taxed as an S Corporation to avoid self-employment taxes.
What is the tax difference between sole proprietorship and LLC?For federal tax purposes, a sole proprietor's net business income is taxed on his or her individual income tax return at the proprietor's individual tax rates. A single-member LLC is a "disregarded entity" for tax purposes—that is, it is taxed the same as a sole proprietorship.
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