LLC vs. Sole Proprietorship
LLC vs. Sole Proprietorship
Choosing the right business structure for your company is an important part of starting up any new business. If you are like most entrepreneurs, you are weighing the relative benefits of the two most popular small business structures—sole proprietorships and limited liability companies (LLCs). The benefits of sole proprietorship revolve around their simplicity and low cost. The benefits of LLCs revolve around their flexibility—including method of taxation—and their liability protections for owners.
LLC vs. Sole Proprietorship
To avoid confusion before choosing one or the other, you should evaluate the strengths and weaknesses of each as they pertain to your needs. Here are their principal features:
- The limited liability that LLCs provide for their owners
- Sole proprietorships are generally less costly than LLCs
- LLCs need to register with the state and pay registration or filing fees
- LLCs often have annual fees you must pay to maintain registration
- LLCs are subject to state laws governing LLCs
- With an LLC, you must keep LLC records and funds separate from your own
- Operating as a sole proprietorship, you are taxed as a self-employed person
- LLCs can be taxed as sole proprietorships, partnerships, or corporations
As important as understanding the differences and similarities between LLCs and sole proprietorships is in making the right decision for your business, you also don't want to overlook the concepts and definitions determining these differences.
If you’ve been thinking about choosing between an LLC or sole proprietorship, it’s important to understand both the similarities and the differences between the two. Each business structure has its own advantages and disadvantages, and the best business structure for your business will depend on your specific circumstances.
LLC stands for “limited liability company,” meaning limited liability is one of the main advantages of an LLC over a sole proprietorship. What does limited liability mean? Unlike a sole proprietor, where the owner remains responsible for the debts and liabilities of the business, in an LLC it’s the LLC that’s responsible for the business’s debts and liabilities. This means, in most cases, LLC members are protected from the creditors of the LLC and also from any lawsuits which may arise against the LLC.
Start-up and Maintenance Costs
Other than the fees for obtaining any required licenses or permits, setting up a sole proprietorship generally doesn’t entail very many other costs. LLCs, on the other hand, will need to register with the state and pay initial registration or filing fees. As well, there are often other fees, such as annual fees which must be paid to maintain your registration as an LLC in good standing.
In addition to filing fees and annual fees, LLCs are also subject to state laws governing LLCs. Depending on the state in which you register your LLC, these laws may require you to have an operating agreement for your LLC, or a registered agent. Often the regulations result in additional paperwork, such as annual information statements or reports which must be filed in a timely manner. Sole proprietorships, on the other hand, are not subject to similar regulation.
State regulation of LLCs include required words which must be included in an LLC name—for example, “LLC” or “Limited Liability Company” might be required at the end of an LLC’s name. Sole proprietors do not face any such requirements and generally need only to make sure they are not using a name that’s being used by another business operating within the same state.
Separation of Business from Personal
When you’re operating as a sole proprietor, you don’t have to worry about intermingling your business funds with your personal funds; in the eyes of the law, they’re regarded as one and the same. When running an LLC, however, you must be careful to keep both LLC records and funds separate from your own personal records and funds. Violating this rule—for example, by intermingling your personal funds with LLC funds—can result in the loss of your limited liability protection.
LLC Taxes vs. Sole Proprietorship Taxes
If you operate your business as a sole proprietor, you’ll be taxed as a self-employed person, and the income of your business is considered your personal income for tax purposes. An LLC, however, can be taxed as a sole proprietorship, a partnership or a corporation. An LLC may make an election to be taxed as a corporation; if such an election isn’t made, it’s taxed as either a sole proprietorship or a partnership, depending on the number of members it has. It’s probably this potential of an LLC to be taxed as a sole proprietorship which often has people wondering if an LLC is a sole proprietorship. It’s not, but for tax purposes it may be taxed as one, depending on the circumstances.
The choice of business structure is an important one for every business. With two of the most popular business structures for businesses being LLCs and sole proprietorships, knowing the advantages of a sole proprietorship vs. LLC, as well as the disadvantages, can help you to make the best decision for your business.
LegalZoom can help you start an LLC or sole proprietorship quickly and affordably. Answer a few simple questions to get started. We'll file your paperwork with the appropriate state agency and mail you your completed application.