Starting a new business comes with a lot of decisions, not least of which is how to set up and run your startup. If you’re seriously considering getting into business for yourself, you’ve probably heard about sole proprietorships and LLCs as types of business structures, but what is the difference between the two, and which would be right for you? Understanding both can help you come to the right decision.
What is a Sole Proprietorship?
As the name suggests, a sole proprietor is a business that is owned by a single individual. Many local artists, merchants, or freelancers running a business from a kiosk or out of their home may be operating their respective businesses as sole proprietorships, given the relative ease of doing so.
Benefits of a Sole Proprietorship
- Ease of setup. Unlike other business entities, there’s no paperwork involved in having a sole proprietorship (save for the business licenses you’ll need regardless of structure.) A sole proprietorship is an unincorporated business, meaning that the owner can simply start operating.
- Simple to dissolve. Because a sole proprietorship doesn’t involve lengthy paperwork to create, there’s little to undo should you decide to wind down your business.
- No ownership disputes. Corporations run by two or more people can fall prey to infighting, despite their best efforts otherwise. As the only owner of the business, you can make every decision without having to compromise or capitulate.
- Tax status. Business profits and losses for a sole proprietorship are passed through to the individual tax returns of the owner, which avoids having to pay taxes as a corporation at a higher rate.
- Tax flexibility. Depending upon their preference, LLCs can be taxed as sole proprietorships, with profits and losses passing through to individual tax returns, or as S-Corporations or C-corporations.
Disadvantages of a sole proprietorship
- Lack of liability protection. Because the business is not distinct from the owner in a legal sense, those operating a sole proprietorship face unlimited liability for the debts and obligations of the business.
- Fundraising difficulties. If a side project turns into something more that you’d like to grow, operating as a sole proprietorship makes it difficult to get investment or funding without the ability to issue stock.
- Tied to the owner. If the owner of a sole proprietorship dies or otherwise decides to stop operating the business, then the sole proprietorship ceases to exist; in the event of death, the assets of the business are added to the estate and are possibly subject to estate tax.
What is an LLC?
A limited liability company (LLC) is a business entity that is distinct from its owner or owners, and offers greater protection and structure while maintaining flexibility. LLCs are a popular choice from many business owners because they bring together popular features of corporations and sole proprietorships into one entity.
Benefits of an LLC
- Liability protection. Provided that the LLC is structured and operated correctly, it shields its owners from the debts accrued by the business, save for instances of fraud or malfeasance.
- More than one owner. Multiple owners can be a detriment, but it can also serve as a benefit. LLCs with more than one owner can, split the duties and responsibilities of running the business, and can memorialize the arrangement in an LLC agreement. LLCs can also take on members that are simply investors and are not part of day-to-day operations.
- Tax flexibility. Depending upon their preference, LLCs can choose to be taxed as sole proprietorships, with profits and losses passing through to individual tax returns, or as S-corporations or C-corporations.
Disadvantages of an LLC
- Cost. While LLCs do offer significant advantages to sole proprietorships in terms of protection, there are also greater costs involved at the start to create an LLC vs a sole proprietorship—costs that some may not be willing or able to pay at the outset. Many states also require LLCs to pay an annual fee and file reports.
- Self-employment taxes. By choosing to be taxed as a pass-through entity, LLC owners are subject to paying Social Security and Medicare taxes on their salaries and profits.
- Transferring ownership. While it’s not impossible, it’s far more difficult to transfer ownership in an LLC in comparison to a corporation, where owners can simply sell their shares but still better than a sole proprietorship.
What are the Differences Between an LLC and a Sole Proprietorship?
Every potential business owner should examine the differences between LLCs and sole proprietorships to determine which is the best option for their own needs. There’s no right answer to be found, per se; the answer is the business structure that is right for you.
LLCs and sole proprietorships differ in significant ways. The most significant is protection: whereas sole proprietors are responsible for any and all of the business debt they accumulate regardless of whether they choose to shut down that business, those operating with an LLC are individually protected against the debts under the name of the business. But LLCs are subject to more formality; there’s paperwork and fees involved in formation and upkeep, and additional owners means figuring out decision-making and division of responsibilities.
LLC vs Sole Proprietorship: Business Formation
If you’re looking at operating as a sole proprietorship, formation is a simple process relative to your other options. Because a sole proprietorship is an unincorporated business, there’s no work to do with filing paperwork with the state to create an entity. All that is required is getting the necessary permits and licenses needed to operate a business and filing a trade name with the state, in the event you’re not operating under your own name.
LLCs, on the other hand, require choosing and filing a name for your LLC, creating and filing articles of organization, choosing a registered agent to receive notices, creating an operating agreement, and deciding on whether the LLC should be managed by its members or by a designated manager. It’s considerably more work, but it’s worth it for those looking for the benefits offered. And the work is considerably easier with the help of a LegalShield provider lawyer walking you through the process every step of the way.
Tax Benefits of LLC vs Sole Proprietorship
LLCs and sole proprietorships both allow their owners to pass through the income and losses of their businesses to their personal taxes, thereby avoiding what’s known as ‘double taxation’ where corporation owners pay taxes on corporate income as well as taxes on the dividends they’re awarded by the corporation. LLCs, however, do have the option of electing to be taxed as a C-corporation or S-corporation, which can be advantageous for those LLC owners who are looking to delay distributing profits for tax purposes or save on self-employment taxes.
Why Choose LegalShield to Structure Your Business
It’s hard to know what your needs are for a business entity, and even harder to try and work through the entire process yourself. Cost is the main reason most would try to do it themselves, but with LegalShield, cost isn’t a barrier to getting the legal help you need. You can work with a lawyer to ensure which business formation process is right for you and that the process is done correctly the first time. Start your business now with LegalShield.