Sole Proprietorship vs. LLC: Which One Is Right for Your Business?

Last Updated:
December 7, 2021
Author:
Mike

Sole Proprietorship vs. LLC

Did you know that there were over 4 million new business applications in the US in 2020? As an entrepreneur deciding your business structure is a key turning point. Not only will it impact your management structure, tax implications but also other operational processes. Thus, you must decide on what entity type to use. Below we look at sole proprietorship vs. LLC as business entity options.

What is Sole Proprietorship?

This is when a business does not set up a separate legal entity. Instead, all business runs through you as the entrepreneur. This is the simplest and least expensive type of business formation. Any individual who operates a business on their own is by default a sole proprietor unless they register as a different business entity. Some states, however, require you to register as a sole proprietor business.

What is an LLC?

An LLC or Limited Liability Company is a legally separate business entity. It combines elements of a sole proprietorship, partnership, and corporation while offering a lot of flexibility for owners. A single person can form a single-member LLC or multiple partners can form a multi-member LLC. Any business registered as an LLC must use LLC after their business name. To register, an LLC must file as an organization and then submit an annual report each tax year.

Management Structure for Sole Proprietorship vs. LLC

When operating as a sole proprietor, you are solely in charge of any and all decisions. However, this does not mean that you can’t hire employees. In fact, many sole proprietors hire employees, legal experts, and accountants to help with the day-to-day operations of their business. But, as all financial, tax, business insurance, and legal details are under your name, you are ultimately responsible for all business decisions.

With an LLC however, the management structure is more complex. It will be laid out in an LLC operational agreement during formation. This document outlines each member’s stake in the business, along with their voting rights and profit share percentage. These details are crucial when it comes to making business decisions. Each member will get to vote on decisions using their ownership stake. For example, if a member has a 33% stake, then their vote is one-third of company matters, whereas a member with a 10% stake has a vote of one-tenth. This can make things much more complicated when making decisions, especially if there is a tie in the voting process.

Taxes for LLC’s vs Sole Proprietors

Both sole proprietors and LLCs are automatically pass-through entities. This means the business itself does not pay income taxes. Instead, the owner reports business income through a Schedule C attached to their personal income tax return. This income will then be taxed at the personal income tax rate. If any employees are hired, the business owner must also pay payroll taxes for those employees. You also must collect local and state sales taxes for any taxable services or goods. The final tax requirement for both an LLC and sole proprietor is paying self-employment tax to cover Medicare and social security obligations.

Now, an LLC can choose to either stick to pass-through taxation like above, or choose corporate tax status. If they choose this route they can become an S-corporation (still a pass-through entity) or C-corporation. A C-corporation tax status means the LLC will pay a flat 21% corporate income tax at the federal level. However, there may also be additional local or state taxes to consider. This option can sometimes save LLC money, however, it is not always the case. We recommend you discuss your options with a business accountant before choosing your tax registration status.

Legal Protection Differences for a Sole Proprietor vs. LLC

As a sole proprietor, there is no legal separation between the person and the business. This means that the owner is solely responsible for any business debts, or lawsuits. Thus, if the business goes bankrupt, the sole proprietor will file for personal bankruptcy and include both business and personal debt in the filings. Additionally, if someone chooses to sue your business for any reason, they can come after your personal assets as a sole proprietor.

Now, as an LLC your personal assets are protected. This is because an LLC is a completely separate entity from you as the owner. Thus, you are not personally liable for any business debt or lawsuits. An LLC can file for bankruptcy if needed and will not need to pay creditors from their personal finances. The LLC filing also protects owners in most lawsuits. The only exceptions are typically fraud, negligence, or personally guaranteed debts.

So, What Is The Best Choice?

Unfortunately, there is no one right answer. Most businesses will start as sole proprietors because it’s easy and there is minimal paperwork. However, as your business grows it may be worth considering switching to an LLC. Some businesses may even find it best to register as an LLC initially due to the high financial risks in some industries. Thus, when considering a sole proprietorship vs. LLC you should first look at your business plan and risk assessment to help decide. It is also recommended to talk with others within your industry and discuss the options with your business accountant.

© 2021 Add Value Business Blog    Contact   -   Privacy

magnifiermenu linkedin facebook pinterest youtube rss twitter instagram facebook-blank rss-blank linkedin-blank pinterest youtube twitter instagram