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LLC vs. Sole Prop: What Should You Choose for Your Business?


Working from home

Choosing the right business entity for your company is not an easy decision. Before choosing one, it is important to understand the different types of business entities available to you and their tax effects. This will help you decide what is best for your situation. Below, we explain the differences between the two most common forms of entities, the Limited Liability Company (LLC) and Sole Proprietorship, to help you determine which would be best for your business.


What Is a Sole Proprietorship?


Sole proprietorships are the simplest type of business entity. They don't require any formal paperwork or legal filings. All you need to do is start doing business under your own name, using your own funds and property to run the company, and any profits that come in will be taxed as personal income. With this in mind, understand you will be liable for any debts or liabilities incurred by your business as well as its profits — so if someone sues your company, they can go after your personal assets instead of just those owned by the business itself.


What Are the Advantages of a Sole Proprietorship?


Flexibility: If you're just starting out as an entrepreneur, a sole proprietorship offers more flexibility than other business structures because it doesn't require any kind of registration with state or federal authorities. You can get started right away without spending money on legal fees or filing forms with the government.


Tax Savings: As long as your profits stay below $400,000 per year (or $425,000 if you're married), you'll pay tax at your own individual tax rate instead of self-employment tax like other businesses do. That means you won't need to deal with quarterly estimated payments or quarterly tax returns.


Easy Expansion: If your business takes off, there's no limit to how much revenue it can generate or how many employees it can hire. This means that your business can scale much more quickly all while reaping all the benefits.


What Are the Main Disadvantages of a Sole Proprietorship?


There are some disadvantages to a sole prop. For example, if you don't have a business partner or an investor, you can't raise money from outside investors. It's also harder to grow your business because there's only one person making all the decisions. There's no one else to delegate tasks to and no one to bounce ideas off of. The biggest disadvantage is that you're personally responsible for any debts or other liabilities your company incurs, including taxes and fees owed on those debts. If your business fails, so does your personal credit rating. If you can't pay what you owe, the courts could even garnish your wages or seize assets like bank accounts or property in order to satisfy those debts.


What Is an LLC (Limited Liability Corporation)?


An LLC is a legal structure for businesses that combines the advantages of a partnership and those of a corporation. Like a partnership, it provides its owners with limited liability, which means that they aren't personally responsible for any debts or liabilities incurred by the company. However, unlike a partnership, LLCs allow their owners to enjoy some of the benefits of being incorporated without having to pay taxes at both state and federal levels.


What Are the Advantages of an LLC?


Limited liability protection: This is probably one of the biggest advantages offered by an LLC — it allows its members (owners) to limit their personal liability when they enter into contracts or other agreements on behalf of their company. This means that if someone sues your company over a contract dispute or another type of lawsuit, all members (except those who acted intentionally) will be protected from any financial losses resulting from such litigation.


Pass-through taxation: Unlike corporations, which have to pay taxes on their profits at both the federal and state levels, LLCs are "pass-through" entities for tax purposes. This means that any profits or losses pass directly through to members' personal income tax returns — so if you're operating as an S Corp or C Corp, you'll need to file two sets of tax forms each year (one for yourself and one for your business).


Ownership structure: Owners of an LLC are called members and they can be individuals or other businesses (called “single-member” LLCs). Ownership interests in an S corporation are known as shares, which can only be owned by individuals (not by other corporations). An LLC may have one member who owns all of its shares or multiple members who each own part of its assets and profits. In contrast, all shares must be owned equally by all stockholders in an S corporation.


What Are the Main Disadvantages of an LLC?


There may be additional costs involved in starting up and running an LLC, compared to other entity types. These costs may include paying for legal advice or creating formal operating agreements with other members of your LLC. You will also need to pay state fees and file paperwork with your state’s Secretary of State office or similar agency in order to register your business as an LLC. In addition, it is not uncommon for businesses that are initially set up as an LLC to later choose to convert into another type of business structure would end up paying additional fees in order to complete this conversion process.


Common Industries That Are Either a Sole Prop or LLC:


Most small businesses start out as sole proprietorships because they don't have as much money to invest or because they don't have any employees. Business types that typically use a sole proprietorship are those who tend to work for themselves. Businesses that commonly file as a sole prop include:

  • Photographers

  • Freelance writers and designers

  • Musicians

  • Artists

  • Side Hustles

  • Mobile Pet Groomers


Doctors Office

An LLC is a legal structure that allows owners of a business to split income with other members of the company who have a stake in its success. LLCs typically have fewer restrictions than traditional corporations do, but they also have fewer tax benefits.

Businesses that commonly use LLCs include:

  • Real estate agents

  • Contractors

  • Service Providers

  • Physician Offices

  • Law Offices

  • Brick & Mortar Locations

  • Manufactures

How To Form an LLC:

Create an LLC using the following steps:

  • Select a business name, and then choose a registered agent to act as the legal intermediary between your business and the government.

  • File the articles of organization with your local Secretary of State, and outline the basics of your business.

  • Write up an agreement for the operations of your LLC, outlining topics like profit distribution, management structure, and other details.

  • To identify your small business or separate it from your personal finances, apply for an EIN with the IRS.

  • Be sure to get all the permits and licenses you need to start your business. These permits and licenses vary by region, so make sure you are obtaining the proper documentation.

  • To protect your personal assets, open a business bank account and separate personal and business finances.

How To Form a Sole Prop:

Create an sole prop using the following steps:

  • To start a sole proprietorship, you'll first need to create a business name and register it under that name. With sole props, you can either choose your personal name or you can file as a different name.

  • In order to establish your sole proprietorship, you'll need to apply for various licenses or permits. The required items depend on your business type and local state laws.

  • If you're looking to hire employees, you should file for an employer identification number (EIN). Sole props generally use their social security numbers as their tax ID number. However, in order to hire employees, you'll need a new filing with an EIN. You can file for an EIN through the Small Business Administration's website.

  • Although not required, it's recommended that you open a business bank account. This allows you to accept credit card payments and build your credit history. A separate account also lets the IRS know your profits vs. your losses.

Conclusion


Ultimately, choosing between an LLC and a Sole Prop will be one of the most important decisions you make early on in your business's life. Although both can come with serious costs and potential downsides, some businesses may be better suited for one or the other. The key is to ensure that you are aware of both before choosing one over the other; this will help you avoid many costly mistakes down the road. In the end, it depends on your business. Consider what you're looking for in a business structure, your profit goals, and your tax preferences. For any other questions that come up along the way, there's no shortage of legal resources out there to help guide you through the process.