Start Your Small Business: LLC vs. Sole Proprietorship
One of the biggest questions any new business faces is this:
Should I run my business as an LLC or a Sole Proprietorship?
I want you to start your business off on the right foot, so below, I’m breaking down
what each of these entities is;
what they mean from a liability and tax perspective; and
why you may want to choose one or the other.
Before we dive in, just a few things to keep in mind:
I’m not a licensed tax professional or licensed to give legal advice. What I WILL happily provide is general advice based on my experiences as a business owner. If you have specific questions, please direct those to a legal professional.
All information in this post is geared toward businesses based in the United States.
There are several types of LLCs. For the sake of this post, I’m focusing more on sole owner LLCs and partnership LLCs (those without salary requirements).
Now: let’s get started!
What is an LLC or Sole Proprietorship?
In the simplest terms: a sole proprietor is a one-person business or one- business owner.
As soon as you start providing a good or service that someone pays you for, you are a sole proprietor. Without declaring any business name or filling out any forms, you become a sole proprietor by default.
You can declare a business name and file a DBA and start representing your business under that name, but you’re still a sole proprietor under the law until you register the business as its own entity.
LLC stands for Limited Liability Company. It’s a company that you form that has a limited liability to you as the owner or partner.
You set up a separate entity that runs the business that is not you.
You OWN the entity, but you and the entity are completely separate things.
You must fill out a form to become an LLC in your state — and the fees and exact procedure can vary by state.
So which one do you choose for your business?
The easiest thing to do is be a sole proprietor. No forms to fill out — you just start working and selling your goods and services.
Any money you make in this case, you report on your personal income tax return. The IRS then taxes that income minus any expenses, just like it would tax money made at a day job. In addition, the IRS also adds on a self-employment tax, which includes your social security and medicare.
The difference between how this operates versus when these taxes are taken out from your day job paycheck, your employer pays half of the social security and medicare taxes, and you pay the other half. As a sole proprietor, you pay the full amount (currently 15.3%). Thus, you are taxed a bit more as a sole proprietor than through your day job under a different employer.
If you live in a state that charges income tax, you also will have to pay that at the state level.
With an LLC on the other hand, you file a separate tax return because the LLC is its own entity.
When filing taxes for the LLC, you’ll be asked to check a box for the type of LLC you are registered as:
Sole Owner LLC
Partnership LLC
S Corp LLC
C Corp LLC
As mentioned earlier, for the sake of this post, we’re checking either the Sole Owner LLC or Partnership LLC box.
When you check the sole owner or partnership box, this tells the IRS to disregard the LLC as an entity of its own for tax purposes only. So this means that when it comes to taxes, there’s no difference between the Sole Proprietor and the Sole Owner or Partnership LLC.
The only additional charge you should experience is the fee from your accountant for filing the additional form associated with the LLC.
Note: There is a threshold of profit made when it makes more sense to declare yourself as an S Corp or C Corp LLC versus the Sole Owner or Partnership LLC.
Why is it even worth forming an LLC if it’ll cost additional money but doesn’t change anything when it comes to my taxes?
The most important difference between a sole proprietorship and an LLC is the issue of liability.
With a limited liability company, you’re paying for the additional level of protection that the LLC offers you. As a sole proprietor, if anything goes wrong in your business, you have no protection; you are entirely liable for any wrongdoing. There’s no separation between your personal assets and your business assets.
With an LLC, the business is a separate entity. The owner(s) are not personally liable for the debts and responsibilities of the business. Your personal assets are protected.
Let’s take a closer look at each one:
WhY to choose a Sole Proprietorship:
Ideal for low risk businesses or for testing a business idea with no customer transactions
Zero establishing costs
Tax filing is easy
WhY to choose an LLC:
Ideal for medium/high risk businesses who are actively engaging with customers
It’s a separate legal entity
Helps you establish credibility
When choosing which is best for you, think of your immediate business objectives. You can always start as a sole proprietorship and transition to an LLC later — or if you think things will move quickly and you have a large audience, starting as an LLC might make more sense. You’ll be thankful for that extra level of protection.
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