Sole Proprietorship Vs. LLC

You know, what’s going on around here? Too much! The global economy is slowing down, and inflation rates are rising to levels that haven’t been seen in decades. Russia’s invasion of Ukraine and the COVID-19 pandemic are the main reasons for this situation. In this situation, many people are choosing business as their profession.

 Some people are concerned that they are meant to be born for business at an early age. Some choose business as a career due to retirement, job termination, or parenthood.

You may take your time before making this big decision to step into business. You have to mentally prepare yourself for stepping out of your comfort zone. You must create a business plan, including a business name and structure.

Choosing the right business size is an important decision. Based on simplicity and flexibility, there are two popular entity types: sole proprietorships and limited liability companies (LLCs). Now, the fact is, which one do you choose—a sole proprietorship or an LLC?

This blog will clearly explain the difference between these two popular business structures.

Why Is Launching a Business Beneficial?

Suppose you are planning to launch a business or are still trying to understand how to make decisions. In that case, you must know the importance of establishing a business before moving on to the main topic. There are many benefits for entrepreneurs, like:

• One of the main advantages is self-employment. You have the opportunity to work according to business needs and design.
  
  
• When you do a job under the direction of company owners, it’s hard to find motivation in the workload. But when conducting your own business, you will naturally deliver more productivity.
  
  
• As mentioned earlier, some people are concerned that they are meant to be born for business. So they start a business to follow their dreams for personal fulfillment. Ultimately, they shape the business for the next generation.
  
  
• One can give extra time for business necessities during their flexible hours.
  
  
• Not only for personal fulfillment or self-employment, starting a business has become necessary for economic development. One person can have different businesses simultaneously, which creates the chance for economic expansion in return for taking risks. This generates a source of revenue in the global economy.
  
  
• As a business owner, you can keep an eye on various departments, from HR decisions to inventory management or customer support. This will help you develop a broad range of skills, including creativity.

What Kind of Liability Protection Do You Want?

Before starting a business, you should learn about liability protection. Liability refers to being responsible for financial and other legal responsibilities. Starting a business is way more challenging than working as an employee for a company.

You must be partially liable for any negative effects of what you sell as a business owner. Imagine you borrowed a loan for your business. The outstanding balance will be counted as a liability. You could be liable for paying the fines for damages under the rules and norms.

Registering the right structure for your business is the easiest way to ensure liability protection. Because your liability depends on the business structure you form. For example, if you register your business as a limited liability company (LLC), the business’s liabilities will be separated from yours. And the business will be responsible for taking on all debts.

You will need to obtain some kind of liability insurance in this case. This will save you from common types of company-focused claims like medical payments and fines for damages to property from business operations. You can also buy product liability insurance with additional coverage for specific products. However, this won’t protect you in terms of legal liabilities.

So, to get rid of your business debts personally, you should ensure liability protection.

What Kind of Taxes Should Your Company or Business Pay?

This answer is very simple. The kind of legal structure you choose determines the taxes you need to file. For this purpose, you have to register your business legally. Different types of businesses are taxed differently. If you register the wrong business entity, you might have legal issues with government tax agencies. Also, you have to pay more than you are supposed to.

For example, if someone registers their business as a C corporation, they may face difficulties, legal issues, and extra taxation. Therefore, an S corporation will be the better option for you.

 When you know what kind of taxes your business needs to file, conducting business and maintaining the law will become easier.

What Kind of Business Structure Can You Choose?

Beginning a new business is an exciting adventure. Choosing the appropriate legal entity for your company is one of your most critical decisions. The right business structure also determines taxes, liability, paperwork, fundraising, and potentiality.

Because the kind of company you run will affect everything from your taxes to your legal obligations, it is essential to gather as much information as possible before making a choice.

The most common business structure are described below:

• Sole Proprietorships: Sole proprietorship businesses are one of the most popular business structures for beginners. You will have complete power to control your business. You will have to take responsibility for any kind of debt, loss, or profit in this business structure.
  
  
• Partnerships: When two or more people do business together, this is called a partnership. Different kinds of partnerships exist, like general, limited, and limited liability partnerships. Each partner contributes capital, labor, or skills and shares the losses and profits. In partnership, owners can divide the workload and split the profits and losses. One major drawback is that the owners are individually responsible for the company’s debts and legal obligations.
  
  
• Corporation: A corporation is a type of legal entity that people, stockholders, or shareholders create to run for profit. Businesses can enter into contracts, sue and be sued own assets, pay federal and state taxes, and borrow money from banks or financial organizations. Corporations offer maximum liability to their owners. You can raise funds by issuing shares to an operating corporation. It’s subject to more regulations and formalities, and both corporations and stockholders must pay taxes.
  
  
• Limited liability company (LLC): A limited liability company is a business entity that combines a corporation’s liability protection with a partnership’s simplicity. It requires more paperwork and formalities than a sole proprietorship or a partnership. Do you know LLC owners are protected from being sued? In an LLC, the owners are distinct from being responsible for the business’s debts and liabilities, and the business’s income and spending are reported on the owner’s tax returns. Also, an LLC can have as many owners as it wants and can be taxed as a partnership or a company.

Which Legal Form Is Ideal for Online Business Ventures?

If you are starting a new business and want to do it online, there are also the same legal structures to pick from for your online business, with pros and cons like traditional ones. Therefore, it is very important to research carefully before choosing a legal business structure online.

You can pick a legal business structure based on the nature and type of your online business and the necessity of liability protection. Knowing the pros and cons of each entity, you can easily decide which business form you want to start.

In a general partnership, two or more people will split responsibility. But in a limited partnership, one person will be bound to regular business operations, and the other will only invest in the business without playing an active role.

Again, in terms of corporations, choosing if you are just a new entrepreneur is unnecessary as you don’t have significant earnings and traffic.

It is very worth considering starting your e-commerce business as an LLC if you want to take on less liability. On the other hand, a limited liability company requires a lot of time and paperwork. But there are fewer regulations, and you have total control over your business by separating personal and business property.

Though the majority of online businesses begin as sole proprietorships or general partnerships with minimal startup costs, you can change the structure in the future according to your needs, like Walmart, eBay, or Alibaba.

What Is a Sole Proprietorship?

As we mentioned earlier, the sole proprietorship is one of the most popular business structures for entrepreneurs; it offers attractive options for newbies. “Sole” means lone or single. A sole proprietorship has a single owner and operator accountable for all debts, losses, and liabilities.

You must pay personal income tax on your business profits as a sole proprietor.

A sole business owner enjoys full control over and profits from the business. As it doesn’t require filing federal or state forms, a sole proprietorship has existed since the start of your business.

Advantages of a Sole Proprietorship

There are many advantages to a sole proprietorship, such as:

• Pass-through Entity: One of the key advantages is that this business structure is a pass-through entity for tax purposes. You don’t have to pay taxes on your business’s income. Instead, you can pay taxes on the income at your tax rate.
  
  
• Business Structure: A sole proprietorship business structure is easier and cheaper to establish than other business entities.
  
  
• Control Power: As you have total control over the business, you can determine the pricing of your goods or services and decide the investment amount or financial budget.
  
  
• Gain Profits: As the only owner of a sole proprietorship, you don’t have to share your business profits with others.
  
  
• Growth of Business: When you conduct a business as a sole proprietorship, you will have more engagement with customers, employees, and the market, which helps the business to grow more.

Disadvantages of a Sole Proprietorship

There is a proverb that says, “Unity makes strength.” In other business entities, there is more than one decision-maker, which opens up various paths for business development.

However, in a sole proprietorship business structure, only one person makes all the decisions, which creates obstacles to finding objectivity for business development.

There are significant downsides along with advantages to this structure. These are given below:

• Uncertain Future: Due to the lack of legal requirements in a sole proprietorship business, there’s no future certainty about who will take over the business after your death. This may create issues in conducting business in the future.
  
  
• Lonely Bearer: There are losses and profits in all types of business. When other business entities make losses, all the firm’s owners take responsibility for the losses. But in a sole proprietorship, you have to be responsible and suffer for all losses.
  
  
• Difficulty in Finances: As a sole proprietorship business can start with small capital, the owner may sometimes find limited funding difficult, such as when you can’t apply for a bank loan for a long duration due to insufficient capital.
  
  
• Liability: In a sole proprietorship, the business owner has to assume all the business liabilities.
  
  
• Less Innovation: There are fewer chances for innovation.

Example of a Sole Proprietorship

As we told you, most of today’s businesses start as sole proprietorships. After a certain time, they may choose to reform other legal structures based on profits, the company’s growth, or new business ideas.

Do you know many famous companies like Walmart, eBay, Kate’s Real Food, JC Penney, etc., started as sole proprietorships? Many small businesses are sole proprietorships for easy establishment and fewer taxes, such as a local grocery shop, freelancers, legal business experts or IT consultants, a local clothing line, an artist, and other self-employed individuals.

How Can You Apply for a Sole Proprietorship?

A sole proprietorship is the simplest legal structure for newbies who want to establish a business. If you are starting your business as the only owner, you don’t have to take any formal action to build your business.

A sole proprietorship starts immediately when you start conducting business. But you must maintain initial licenses and business permits to register your business. There are a few steps given below for starting a sole proprietorship.

• Obtain a Business Name: If you want to start a sole proprietorship business, nothing can be more interesting than coming up with a business name. A business name visually represents any business or its products and services. If you are famous enough in your locality, choosing your name can be key in marketing aspects. But if you choose a separate business name to avoid the risks of using your own name, most localities will require you to file a DBA (doing business as) name.
  
  
• Obtain an SSN or EIN: After obtaining a DBA or business name, you will need a Social Security number for tax purposes. However, you must obtain an Employer Identification Number (EIN) from the IRS to file excise tax returns or plan to have employees.
  
  
• Obtain Business Insurance: Though there are many advantages to sole proprietorship business, there are some disadvantages also. As a sole business owner, you must bear all liabilities for any kind of damages lawsuits, or accidents. In this case, getting small business insurance is a wise idea to reduce these out-of-pocket expenses.
  
  
• Getting a Bank Account: If you are planning to run your business in the long run, getting a bank account is another fantastic idea to organize your business finances. This will allow you to accept credit transactions, a bank loan, or establish a business credit.

What Is an LLC?

A limited liability company is a business entity with one or more owners, which prevents business partners from bearing liability for the company’s financial losses and debts. You will get the best combination of maintaining the status of corporations and flexibility in the taxation of sole proprietorships or partnerships in one business entity. In LLC, members or partners equally

Advantages of an LLC

• Liability Protection: If you are concerned with limiting your personal legal liability, choosing an LLC is your best option. An LLC provides limited liability protection for owners, which means that you or LLC members are not personally liable for any kind of debts or liabilities of the business.
  
  
• Flexibility in Taxation: LLC offers flexibility in taxation. It’s not taxed as a separate entity. LLCs don’t have to pay taxes. Rather taxes and losses pass through the owner’s personal tax returns. So owners pay taxes on their income.
  
  
• Flexibility in Management: LLC offers flexibility in terms of management. This business legal form can be managed by owners or a designated manager.
  
  
• Safety for Personal Assets: In LLCs, personal assets are protected. This can be a good fit for high- or medium-risk entities.

Disadvantages of an LLC

Alongside many advantages, there are also disadvantages to forming an LLC.

• Name Difficulty: If you form your business as an LLC, you have to get a different business name from other LLCs.
  

• Less Control Power: Owners don’t have total control over the Limited Liability Company.
  

• Expenses: Forming and operating an LLC is more costly than a partnership or sole proprietorship.
  

• Ownership Limitation: In terms of ownership, limited liability companies are limited.
  
  
• Personal Tax Responsibility: As taxes and losses pass through the owner’s personal tax return on their share of the income in an LLC, this can be higher than other business structures.
  
  
• Legal Requirements: You must maintain legal requirements like filing articles of the organization and operating agreements.

Examples of Limited Liability Companies

Because of easy formation and limited liability, LLCs are the popular choice for small business entities. Most professional services, cafes, bars, restaurants, builders, and contractors conduct their businesses as LLCs. You will wonder whether brands like Apple, Tesla Motors, The New York Times, and Airbnb operate as LLCs.

How Can You Apply for an LLC?

Starting a limited liability company is slightly different from starting a sole proprietorship, but it’s easy. Here are a few steps you can follow, given below

• Obtain an LLC Name: To create an identity for your limited liability company, having a business name is very important. You must choose a unique business name for your LLC that meets state law requirements. You may need to add “LLC” at the end of your structure name.
  
  
• Appoint a Registered Agent: After deciding on your LLC, you must appoint a registered agent who will receive all official legal documents on behalf of your LLC. You can be your own registered agent. But if you aren’t educated enough about your state’s laws and obligations, you must consider consulting with a business lawyer or appointing an IRS-certified registered agent.
  

• File articles of Organization: This step is mandatory. You have to file articles of organization or a certificate of formation with the Secretary of State’s office, where you will establish your LLC.
  

• Make an Operating Agreement: If needed, you must create an operating agreement for an LLC; even though many states don’t require this, it is good to have one. This ensures that every member of LLCS agrees on their rights and responsibilities.

• Obtain an EIN: Last but not least, in this step, you must get your EIN as soon as possible. Most banks ask for EIN to open business bank accounts for LLCs.

Additionally, you can open bank accounts and register for taxes to meet the state’s requirements for keeping your business and personal finances separate.

Sole Proprietorship Vs. LLC: Key Differences

We already discussed the advantages and disadvantages of sole proprietorship and LLC business structures. But there are some key distinctions between both, as explained below.

• Separation of Assets: In a sole proprietorship business structure, as the owner is personally liable for all business losses, there is no separation between you and your business. But in an LLC, you must keep your business and personal assets separate. This provides liability protection for your personal finances.
  
  

• Taxes: There is a key difference in tax flexibility between LLCs and sole proprietorships. There is an opportunity to choose how LLCs want their businesses to be taxed, whether as an S-corporation or a C-corporation. Though both business structures are pass-through entities, there is little difference in LLCs. If LLCs are taxed as a C-corporation, they must pay corporate income tax at the federal level.

  
  

• Legal Protection: In a sole proprietorship business, both personal and business debts will be included in law proceedings if the business goes bankrupt. There’s the possibility of being involved in the owner’s litigation if a sole proprietorship is sued. Their own assets may be at stake. But there’s less risk of being involved in the owner’s litigation if an LLC is sued.

  
  
• Paperwork and Observance: As we mentioned earlier, establishing a sole proprietorship is very easy. Starting a sole proprietorship requires the least amount of paperwork. A sole proprietor must file only federal, state, or local taxes even after establishing their business. If you form an LLC with multiple members, there are many more responsibilities, such as operating agreements, recording transfers of ownership, etc. On the other hand, a limited liability company has more regulations and responsibilities. LLCs must file annual reports in many states after filing the initial certificate of formation.
  
  
• Cost: You must pay various filing fees to set up an LLC. However, it costs no money to establish this structure in a sole proprietorship.

Sole Proprietorship Vs. LLC Table

Which One Should I Choose?

We are at the most crucial point now. Choosing the right legal business structure is fundamental to starting any business. This depends on your business needs. You should take your time and get suggestions from legal business experts before deciding on your business structure. It directs the length of the setup procedure, the number of expenses, the way of taxation, and the overall body of your business based on your choice.

Sole proprietorships and LLCs are the most popular forms for establishing a legal business structure. But now, many people or business owners need clarification about whether they should form a sole proprietorship or an LLC.

Sole proprietorships and LLCs are the most popular forms for establishing a legal business structure. But now, many people or business owners need clarification about whether they should form a sole proprietorship or an LLC.

If you are concerned about startup fees, choose a sole proprietorship business structure, as an LLC will cost you a few hundred dollars. But in the case of legal protection, it’s always best to start with an LLC for greater flexibility. In an LLC, you will get protection for your assets from any legal action.

Now the decision is yours. There’s no limit to reforming or transitioning your business structure in the future. You can always convert the business form if you see growth and want to share your business with others.

FAQs on Sole Proprietorship Vs. LLC

Q1: What is unlimited liability?

Answer: Unlimited liability means the full legal responsibility of business owners or partners for any kind of business debt if the company cannot repay it in a sole proprietorship or general partnership business structure. All partners will be equally responsible for the repayment of debts in the general partnership.

Q2: Is an LLC a sole proprietorship or a corporation?

Answer: No, a limited liability company is neither a corporation nor a sole proprietorship. However, it combines a corporation for limited liability with the simplicity of a sole proprietorship.

Q3: Is sole proprietor the same as self-employed?

Answer: As sole proprietors operate and own their businesses alone, you can call them “self-employed.”

Q4: Is it a good idea to start a business as a sole proprietorship?

Answer: It depends on what type of business you want to form. Suppose you want to avoid the hassles of paperwork like articles of organization, articles of incorporation, and the difficulties and costs of creating a business structure. In that case, you can start with a sole proprietorship.

Q5: When should a sole proprietor become an LLC?

Answer: Most people start their businesses as sole proprietors. But as the business grows, they convert it to an LLC.

Q6: Can you convert your sole proprietorship to an LLC?

Answer: Yes, you can convert a sole proprietorship to an LLC to separate your personal assets from the entity.

Q7: How do you convert a sole proprietorship to an LLC?

Answer: If you want to transition your sole proprietorship to an LLC, the owner must go through the state’s procedures. First, you must file a DBA again (doing business as) in the company’s name that is available only to you. Then you must file an article of organization, make an operating agreement, obtain an EIN from the IRS, and keep your reformed business structure active.

Q8: Which is better, a sole proprietorship or an LLC?

Answer: A sole proprietorship best fits small businesses with low risk and low profits. Because in a sole proprietorship, you must be liable for all debts and losses, which may cost you more. On the other hand, it’s worth forming an LLC, as it separates your personal finances from your business.

Q9: Do I need insurance for an LLC?

Answer: Yes, you need insurance coverage for high-risk industries like construction and manufacturing. But sometimes, you need insurance for your low-risk companies. This covers your LLC’s problems, like accidental damages or injuries. This protects your personal assets against state lawsuits.

Final Verdict

In summary, if you want to start or are already doing business, you must acquire knowledge about each entity. It determines your business structure, chances of risks, file of taxation, and potentiality of business growth. If you need liability protection and have several partners or owners, you may choose an LLC.

But if you have a limited budget or want easy formation, you can choose sole proprietorship. Whether starting with a sole proprietorship or LLC, you can change the business structure later. We suggest you get legal advice from any professional business expert to decide on the online or physical structure.

Happy entrepreneuring!