LLC vs. Sole Proprietorship: Which is Right for You?
Beginning a new business entails a number of significant challenges. Among them is probably identifying the most appropriate business structure. For small business owners, the Limited Liability Company (LLC) and Sole Proprietorship are two of the most common options. Each structure has benefits, but the decision is a function of your goals, risk tolerance, and objectives for the future. To help reach the best decision, we describe the major differentiators between the two.
1. Understanding the Basics
The Sole Proprietorship is the simplest business structure. One person owns and runs the business, and there is no legal separation between the owner and the business. This also means that the entire profit goes to the owner, but so do all the obligations and liabilities of the business.
In contrast, an LLC is a distinct legal entity. LLCs provide limited liability, meaning that a business owner’s personal belongings, like a house and car, are protected from the business’s legal troubles and debts. This structure is the most ideal, and combines the simplicity of a sole proprietorship and the liability protection of a corporation.
2. Liability protection
The principle difference between an LLC and a proprietorship is liability.
- In a Sole Proprietorship, the person operating the business carries all the responsibility. The owner’s personal belongings can be seized if the business gets sued or gets debt to pay.
- In an LLC, the owner’s personal belongings is shielded by liability. The creditors can only go after the business assets, and can’t obtain the owner’s personal belongings.
If any of the risks (financial, legal, operational) involved in your business can go operational, an LLC will be your best shield.
3. Taxes and Financial Flexibility
For both business structures, the owner’s business profits and losses can be reported on the personal tax return, meaning the owner does pass-through tax. LLCs just offers greater tax flexibility.
- In the Sole Proprietorship, the owner is taxed once, but will pay self-employment taxes on all profit.
- In the LLC, the owner can choose how they want to be taxed, which will be classified as a sole proprietorship, partnership, S corporation, or C corporation. This will give more control and greater tax saving.
If you anticipate growth in your business, or if you are planning on adding business partners, the tax flexibility of an LLC makes it a better scalable option.
4. Setup and Maintenance
Starting a Sole Proprietorship is cheap and easy. Just register your business name and you can start. For an LLC, you need to file Articles of Organization, pay some state fees, and create some records to keep. Even though you will have to deal with a little bit more paperwork, an LLC will have legal protection and more credibility.
5. Credibility and Growth Potential
Having an LLC means you have more credibility, and your business will be seen as more professional. That can help you win some contracts or even form some partnerships. A sole proprietor is good for someone working as a freelancer, a consultant, or a very small business. An LLC is better for someone who wants to grow their business.
Conclusion
Everything depends on your business goals, balance sheet, and how much risk you want to take. For more simplicity and as you’re starting small, a sole proprietorship will do. For more scalability, tax flexibility, and liability protection, go for an LLC.
Finding and modifying an LLC structure can sometimes be tricky. For more information, check out — How Does Removing a Member Change an LLC Structure?
