What is Sole Proprietorship vs LLC?
For business owners just starting out, this guide is for you. Learn about the two common business structures for young companies.
Whether you’re offering freelance accounting services, opening a brick-and-mortar surf shop , or selling handmade clothing online, starting your business is full of challenges and big decisions. And one of the most important decisions you have to make early on, is the type of business structure your business will adopt. For many, new small business owners, they are choosing between the following business structure types: a sole proprietorship vs a Limited Liability Corporation, often referred to as an LLC.
Many small business owners choose to open a sole proprietorship or a limited liability company (LLC). When choosing the right structure for your new business, take time to consider factors such as initial costs and fees, government regulation and its impact on your company, liability and legal protection, and the potential implications on your tax returns. Don’t worry — we’ll cover these points in this article.
Read on to learn all about the differences between a sole proprietorship and an LLC, and how you can determine which structure is best for your small business venture.
What Is a Sole Proprietorship?
The simplest type of business structure, a sole proprietorship, is an unincorporated business with a single owner. This structure is the default for anyone who operates a business on their own, so you may already have a sole proprietorship and not even realize it.
There are several sole proprietorship pros and cons, but let’s start with the positives:
- No required paperwork to file
- Simpler tax filing
- Self-employed tax benefits, like deducting business expenses
However, in addition to being the easiest business structure to establish, a sole proprietorship is also the riskiest. Here are some of the potential downsides:
- No liability protection against business debts and lawsuits
- Difficult to establish credit
- Challenges getting a small business loan
- Limited opportunities for business growth
What Is an LLC?
An LLC is a type of business structure that offers limited liability protection and pass-through taxation to one or more persons. The main difference between an LLC vs. a sole proprietorship is that an LLC provides its members with liability protection by keeping the business assets and debts separate from those of the individual members. Basically, you don’t have to worry about someone coming after your house or your personal financial assets if your business is in trouble.
Here are a few other advantages of an LLC:
- Easy to apply for and obtain business financing
- Credibility as a company
- Flexibility in tax filing
- Tax benefits of self-employment
Of course, an LLC isn’t for every business. Here are the disadvantages of this business structure when compared to a sole proprietorship:
- Paperwork and filing required with your state
- Annual state filings and fees
- More complex taxes, depending on how you choose to file
Now that we’ve covered the nuts and bolts of these two business structures, let’s take a closer look at the key differences of a sole proprietorship vs. LLC.
Sole Proprietorship vs. LLC: Forming Your Business
A sole proprietorship is easy to create because it doesn’t require you to file any paperwork with your state or local government. In fact, it’s not a formal structure at all (besides getting proper city or county permits or business certificates). If you’re selling goods or services on your own, without a business partner, you have a sole proprietorship by default.
While you don’t have to file any documents to own a sole proprietorship, if you decide to operate under a brand or trade name, you will need to apply for a fictitious business name certificate, or DBA, to create a business name.
In contrast, an LLC is all about the paperwork. The most important document you will need to file is the Articles of Organization (AoO), which establishes your company’s existence and is usually filed with your state Department of Revenue or Secretary of State. The cost to file your LLC’s articles of organization will vary depending on your location, but it generally falls between $25 and $100, with some states charging as much as $500.
Sole Proprietorship vs. LLC: Establishing Management Structure
Setting up an operations and management structure for a sole proprietorship is incredibly simple — after all, there’s only one person in the business (that’s you!). All decisions for the company are yours and yours alone, but many sole proprietors choose to hire employees, as well as accountants, lawyers, and other experts, to help them run the business.
An LLC, on the other hand, typically has a more complex management structure, which is usually outlined in a document known as the operating agreement. While most states don’t require this document, it’s a good idea to create one, especially if it’s a multi-member LLC. An operating agreement is your business’s management bible: It defines each member’s ownership in the business, profit share, and voting rights and clearly describes how business decisions will be made.
Sole Proprietorship vs. LLC: Filing Taxes
If your LLC has only a single member, taxes are relatively simple, just as they are with a sole proprietorship. Both structures are pass-through entities, meaning the business itself is not required to pay income taxes. Instead, the owner reports all business income on their personal tax return. Single-member LLC vs. a sole proprietorship taxes will look very much the same.
What if your LLC has more than one member? A multi-member LLC is also a pass-through entity, and each member reports their share of the company’s income on their individual tax returns. However, a multi-member LLC is taxed as a partnership, so it has to file a business tax return with the IRS, with each member attaching a Schedule K-1 to their personal return.
LLC vs. sole proprietorship taxes also differ in that LLCs may also have to pay additional taxes, such as employee payroll taxes, state and local taxes for goods and services, and self-employment taxes as a small business owner. Your state may also require additional taxes if you have an LLC, so be sure to consult with financial planners for small business before filing to make sure there are no surprises.
Sole Proprietorship vs. LLC: Protecting Your Personal Assets
With a sole proprietorship, you are the business. That means that, if your business goes bankrupt or is sued, your company and personal assets can be jeopardized.
An LLC, however, gives you a legal shield. The members of an LLC are not personally liable for business debts and don’t have to pay company creditors with their own money. Even if someone sues your LLC or you declare bankruptcy, your personal assets are protected.
Perhaps the primary difference between a sole proprietorship vs. an LLC, this legal protection often leads small business owners to open an LLC to help keep their personal and professional lives separate.
Sole Proprietorship vs. LLC: Which Is Right for You and Your Business?
A sole proprietorship makes the most sense when you’re just starting a new business, especially as a freelancer. It’s simple, requires no paperwork filing, and won’t set you back in fees. Plus, taxes will be easy to file — no separate tax return required. As you’re creating a marketing plan and dealing with other details of your new business, a simpler business structure may feel like the right fit.
However, as your business grows, you may want to consider switching from a sole proprietorship to an LLC. While there are more fees and paperwork associated with opening an LLC vs. sole proprietorship, the additional legal protection will be well worth the extra effort.
Fortunately, you can convert a sole proprietorship to an LLC at any time by filing the proper paperwork with your state and paying all the necessary fees.
Long story short: Choosing the best business structure depends entirely on your own business plans, goals, and financial situation. Consult with a business lawyer before making this decision, and set up your small business goals to help you identify which business structure is right for your situation.
How EZ Texting Can Grow Your Business
Now that you understand the pros and cons of a sole proprietorship and an LLC, it’s time to take the next step in setting up your small business goals. Defining your optimal business structure is just one of them.
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