Sole Proprietorship or LLC? How To Choose Your Business Type
As a solo entrepreneur, one of the most important decisions you’ll make is how to structure your business entity. While working as a sole proprietorship certainly has its benefits – like very few filing requirements, for starters – you may be better off forming an LLC. Let’s take a look at the fundamental differences between sole proprietorships and single-member LLCs.
First things first –
What is a sole proprietorship?
Any business owned by a single individual is regarded as a sole proprietorship by default. Sole proprietorships are an attractive choice because they have very few filing requirements or compliance formalities.
In a sole proprietorship, you and your business are the same legal entity.
What is a single-member LLC?
A single-member LLC is a limited liability company that has one owner. Single-member LLCs are an attractive choice because you can protect your personal assets and elect for corporate tax treatment, meaning you can choose to be taxed as a corporation.
In a single-member LLC, you and your business are separate legal entities.
In a sole proprietorship, there is no legal separation between you and your business. That means you are held responsible for all legal obligations and debts incurred by your business. In other words –
If your business gets sued or cannot pay its bills or loans, your personal assets might be at stake.
As a single-member LLC, your business is its own legal entity. This means that you are typically not held personally responsible for debts or legal obligations of the business. In other words –
If your business gets sued or cannot pay its bills or loans, your personal assets may be protected.
In a sole proprietorship, the owner and the business are considered the same entity, so your business’s tax obligations flow through to your personal tax return. This is called pass-through taxation. This means that all of your business income is subject to taxes according to the individual tax rate (~10 to 39.6 percent) and self-employment tax (~15.3 percent). In other words –
If your business income is $100K, all $100K is subject to both individual taxes and self employment tax.
By default, a single-member LLC is considered a disregarded entity. As with a sole proprietorship, your business tax obligations flow through to your personal tax return. However, single-member LLCs can elect for corporate tax treatment, or choose to be taxed as a corporation. This means that only your salary – not all of your business income – will be subject to self-employment tax, and your business income will be taxed at the federal corporate tax rate (~15 to 39 percent). In other words –
If your business income is $100K but you only withdraw $30K as your salary, $100K is subject to corporate taxes but only $30K is subject to self employment tax.
Because the state doesn’t recognize sole proprietorships as a separate legal entity, there are no corporate compliance requirements to run one. That being said, if you are operating under a name that is not your first and last name, you may be required to file a "DBA”, or “Doing Business As” registration form with your state. In other words –
A sole proprietorship has little to no compliance requirements, especially if you are operating under your own name.
Compliance requirements vary by state, but they may include:
An annual report. Some states only require one every two years.
A separate business bank account. All business transactions must be kept separate from the owner’s personal transactions.
An Articles of Amendment, should there be any major changes to your LLC.
A single-member LLC has some compliance requirements, though much less than a corporation.
In conclusion –
Sole proprietorship pros:
Close to no compliance requirements
Sole proprietorship cons:
No legal protections for your personal assets
All of your business profits are subject to taxes
Single-member LLC pros:
Legal protection for your personal assets
Option to elect for corporate tax treatment
Single-member LLC cons:
Some initial filing requirements like an Articles of Organization and an initial filing fee between $50-500, depending on your state
Some compliance requirements, like an annual report and separate bank account
Ultimately, we recommend that you speak with a tax professional to determine what business type is right for you. In the meantime, we hope that this article helped you understand the fundamental differences between sole proprietorships and single-member LLCs.