Sole Proprietorship vs LLC: Key Differences and Considerations

Compare sole proprietorship and LLC to understand key differences in control, liability, and tax implications for your business. Find out which structure suits your needs by evaluating ownership, asset protection, and operational requirements.

By Brad Nakase, Attorney

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Have a quick question? We answered nearly 2000 FAQs.

Table of Contents

1. Introduction

2. What is an LLC with just one member?

3. A single-member LLC’s benefits

4. A single-member LLC’s drawbacks

5. Sole proprietorships: What are they?

6. Sole proprietorship vs. DBA

7. The benefits of being a sole proprietor

8. The drawbacks of being a sole proprietor

9. LLC vs Sole proprietorship: Similarities

10. LLC vs Sole proprietorship: Differences

11. Summary

Introduction

The two forms of doing business that need to be looked at before starting an independently owned company are the LLC & the sole proprietorship.

You must carefully consider your options for a company entity, taking into account control and ownership, asset protection, and potential tax ramifications, in order to make the optimal choice between LLC vs sole proprietorship.

When it comes to LLC vs sole proprietorship there are certain factors that you need to consider to know which type of ownership is better for you. These include control and ownership, asset protection, and the taxes that you will be likely required to pay.

Before you start assessing, don’t forget to:

Understand the primary advantages and disadvantages of LLC vs sole proprietorship.
Each should be looked at in terms of the needs that your company has and the benefits and drawbacks of its application.
Please note that what is relevant for your company is decided by certain unique factors existing in your line of business.

Thus, to make the right decision about the choice in favor of your company, consider the peculiarities and similarities of LLC vs sole proprietorship.

What is an LLC with just one member?

A single-owner LLC is one of the most common categories of small businesses in the United States. This is a structure that has adopted pass-through taxation and limited liability. The registration of the structure is in the state of its creation and is usually the state where the company is operating.

In order to differentiate an LLC owned by a single person and an LLC owned by more than one person, the former is labeled as a single-member LLC. In relation to an LLC, members are used to refer to the proprietors of the business or company. As in the case of a single-member LLC, there are advantages and disadvantages similar to that of a multi-member LLC.

The laws governing the formation of an LLC are different in every state. Either in the state in which you conduct the operation or in a separate state, you may establish an LLC. All states except the one in which your LLC was first created are considered “foreign” states. In certain states, conducting business there necessitates meeting foreign qualification requirements. In most cases, this entails submitting an application for authorization to the business formation filing office of that state.

A single-member LLC’s benefits

The formation of an LLC has numerous advantages over sole proprietorship operations.

In general, personal liability for commercial obligations is excluded for a single-owner LLC.

Remark: As single-member LLCs are entirely owned by one individual, the owner has to be very careful and should not keep their business and personal assets together. This may lead to a cancellation of the limited liability and what is commonly referred to as the veil of the corporation being pierced.

The IRS looks at a single-owner limited liability company as a ‘disregarded entity’, which means that the company is considered to be the owner and vice versa. It is automatically taxed by the IRS in the same manner as any other sole proprietorship.

You can choose to have a different tax rate, though.

Like a sole proprietorship, the owner of an LLC is personally liable for the company’s income tax obligations. Single-membered LLCs are allowed to opt for a different taxation method of the business including the characterization of the business as an S corporation or a C corporation. If you decide to operate your business under the legal structure of a sole proprietorship, you can’t do this.

The following are additional advantages of creating a single-member LLC:

Protecting assets. Huge amounts of personal money and other usable assets of the owner can only be protected from claims and lawsuits if the owner is willing to manage medium-risk or higher-risk companies using LLCs. This is to guarantee that owners enjoy some form of legal shield from personal responsibilities in the event the LLC is involved in an unlawful act. Creditors are therefore unable to liquidate your house, your savings account, or any other personal property so as to recover for company debts.
Independent legal body. From a legal perspective, it can be stated that an LLC is one organization that exists separately from its owner. This means that your LLC is liable for its actions when it enters into contracts, incurs debts, or engages in other legal duties of a business.
Credibility. Compared to operating as a sole proprietorship, becoming an LLC could help a new company in building credibility.
Taxes. At the corporate entity level, LLCs normally pay no taxes. They are all reflected on individual income tax returns whereby the business owners declare all profits or losses realized through the business.

In the end, if you fail to do proper planning, LLCs may not even survive for a while. An LLC must be dissolved in several states if it has zero members, such as when the sole member passes away. By including clauses in the operating contract, such as designating somebody else to take over, state statutes permit the single-owner LLC to continue. One benefit of an LLC above a sole proprietorship is that the latter cannot continue after the death of the owner.

A single-member LLC’s drawbacks

Even while a single-member LLC has many benefits for your company, there are drawbacks you should be aware of.

Cost is one drawback. In addition to one-time costs like franchise taxes and yearly report fees, an LLC must pay state formation charges.

You must choose an agent who is registered in the state before submitting the LLC’s formation paperwork. Legal papers are received on your behalf by this person, who may be a business service company. This is especially helpful in the event of arbitration or other legal matters. The name and address of the registered agent are required in the incorporation paperwork.

Limits on naming. According to your state’s laws, naming a single-member LLC requires you to use the terms “LLC” or “Limited Liability Company” in addition to other requirements. Along with being unique, the name of your LLC must not be the same as any other LLC or company that is registered with the company entity filing office, both domestically and internationally.
Publication prerequisite. In addition to posting notice of the limited liability company formation in the local newspaper or filing an initial report, based on your state, you might also need to file paperwork with the county.
Filings. You will also need to pay franchise taxes and complete periodic files, including yearly or biannual reports, in the majority of states. It’s crucial that you are aware of all possible requirements because these additional files and charges differ from state to state.

Last but not least, keep in mind that if you are unclear about the legislation pertaining to your LLC duties, unintentional administrative dissolution could occur quickly. If you, for instance, believe that you are exempt from franchise taxes because you were exempt from the state’s income tax, your LLC may be dissolved if you neglect to make payments for franchise taxes.

Sole proprietorships: What are they?

The most fundamental type of business organization is a sole proprietorship. As soon as you begin doing business without first forming a corporation or LLC, you are automatically regarded as a single proprietorship.

Your company is an unincorporated enterprise run by a single owner.
Your company and its owner are not two distinct entities.
The assets and liabilities of your company and your personal affairs are intertwined.

One of the key differences from an LLC is that there is no asset separation, thus you could be held personally accountable for the financial obligations and debts of the company.

Sole proprietorship vs. DBA

One form of business structure is the sole proprietorship. Your personal liability, incorporation requirements, and tax payment methods are all impacted by the structure of your company.

Doing business as (DBA) does not constitute a business structure. It is a formal document filed with local authorities that notifies the public that a company is doing business using a name that’s not its legal name. Another name for a DBA is a presumed, fictitious, or trading name.

The benefits of being a sole proprietor

For entrepreneurs who wish to test their startup idea before seeking an official company formation option, or for low-risk firms, sole proprietorships are the best alternative. There are numerous benefits as a result.

Cost. A sole proprietorship is a common choice for business owners with little or no capital as it is free to start.
Authority. Ownership and control over the company remain at 100%. An owner of a sole proprietorship is entitled to both the business’s profits and management.
Maintenance. Once the business ceases, dissolving a single proprietorship is simple. You are no longer a sole proprietor by definition once you cease operations, but you must remember to revoke all business-related permits and registrations. In the event that you created a DBA identity for your company, this also includes removing it.
Taxes. Completing tax forms is simple. Just fill out IRS Schedule C.

The drawbacks of being a sole proprietor

The drawbacks of being a sole proprietorship must be taken into account. This business structure has disadvantages even though the monetary benefits are alluring.

Exposure to liability. Your vulnerability to liability being the firm owner is the main drawback of operating as a lone proprietor. Your business’s debts and commitments are your personal responsibility, so if it can’t pay them off, creditors or litigation plaintiffs may take personal belongings and money out of your personal bank accounts.
Raising money. Since a sole proprietorship prohibits the sale of stock, you can find it difficult to raise capital. Obtaining a loan can be challenging for sole proprietorships because banks are frequently hesitant to lend to them.
Strict ownership guidelines. An Employer Identification Number (EIN) must be obtained if you wish to add a new owner to your company after it has changed. You can convert a single proprietorship into a general partnership by adding an additional owner. You can no longer use your SSN (social security number) to register as the only owner. Form 1065, the United States Return of Partnership Income, must also be utilized for declaring both profits and losses. Additionally, separate K-1s must be filed for each partner’s share.

LLC vs Sole proprietorship: Similarities

A sole proprietorship has its benefits, as does a single-member LLC. Additionally, there are a lot of similarities between the two options in terms of documentation and tax obligations. Gather all the information before making a decision.

Schedule C in Form 1040 must contain your revenue and expenses, regardless of whether you are a lone entrepreneur or the proprietor of a single-member LLC. If you take out cash from the firm or not, you will still be responsible for paying taxes on the net income.
Instead of being deducted item by item, company costs will be deducted from your total revenue. Keeping thorough records of your earnings and outlays is crucial as a result. This guarantees that you are able to deduct all of the allowed amounts.
A sole proprietorship or an LLC may incur charges for things like entertainment, meals consumed while traveling for work, office supplies, and home office costs in addition to car miles for business travel. You can claim a 100% business cost deduction for your personal health insurance premiums if you want to pay for it yourself.
Whether you operate as a sole proprietorship or an LLC, you must obtain a taxpayer identification number along with withholding & paying payroll taxes if you employ any staff members. Your tax identification number is your SSN (social security number) if you don’t have any workers.
Both company structure options entail the requirement that you maintain compliance with regard to licenses & permits. Be aware that these company regulations are typically enforced by local and state governments, such as towns, cities, or counties. However, the federal government also does so in certain circumstances. Whether you go with a sole proprietorship or an LLC, you still need to be mindful of all company responsibilities.
You have two options as a sole proprietor. You can use your own name or select an “assumed company name,” which is also known as an assumed name, Doing Business As, or d/b/a. In the same way, you can conduct business using the LLC’s formation record name, which is also its legal name, if it is a single-member LLC. The LLC may also register a DBA on its own behalf.

LLC vs Sole proprietorship: Differences

Sole proprietorships and LLCs differ significantly from one another. The primary distinction is whether, in the scenario of litigation or debt collection, you personally bear the costs and liabilities of the firm or, as in the case of an LLC, you have limited accountability for such debts and obligations.

When it comes to responsibility and legal protection, an LLC has clear advantages. Establishing an LLC does come with filing fees, but they might be worthwhile when you consider the multitudes of dollars you might be held accountable for as a single proprietor.

However, establishing a sole proprietorship is free of charge. Additionally, anytime you’re prepared, you can switch to an LLC or another type of formation. This implies that shutting down your company and revoking all of your permits and licenses is all that is needed to dissolve it.

Finally, an LLC is subject to a number of startup and continuing fees and filings, whereas sole proprietorships are subject to very few regulations. Attempting to handle this alone may prove challenging, potentially resulting in the omission of crucial documents and consequent fines.

Summary

Consider the requirements of your company while choosing between LLC vs Sole proprietorship. For an aspiring entrepreneur, a sole proprietorship could be a simple and affordable choice, while an LLC would be a better fit for a rapidly expanding company in need of capital. When weighing your options—financial and operational—take your company’s goals into account to ensure that you and your company make the right decision.

Have a quick question? We answered nearly 2000 FAQs.

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