Sole Proprietorship vs. LLC

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Sole Proprietorship vs. LLC

If you're thinking of starting up a new business, you're probably wondering what type of business structure is best for you. Or if you even need to create a business structure, for that matter. There are many differences between sole proprietorships, limited liability companies, and other business entities.

One of the significant differences between the types of business structure is the legal protection that an owner can get. The process required to form business entities also varies, depending on which formation structure you choose. Another big difference has to do with income tax.

Personal Liability for Business Debts

It's a good idea to consider protecting your personal assets when you start up a new business. Sometimes businesses go into debt or owe money to a person or company. If the person or company decides to file a lawsuit against your business, they may be able to go after your personal assets rather than just your business assets. But with certain types of business entities, you have limited liability. This means that the business is responsible for debts, and your personal assets are protected.

A limited liability company (LLC) provides personal liability protection. This is because a limited liability company is a separate legal entity. Personal assets and business assets are kept separate. An LLC owner's personal assets, such as a bank account or car, are protected if there is a business debt or obligation. If the LLC has more than one member, each member also has limited liability for the conduct of other members.

If you don't form a legal business entity, your business is a sole proprietorship by default (or a partnership if you have one or more business partners). Sole proprietorships and partnerships do not offer the same personal liability protection.

If you conduct business as a sole proprietor, you will not have limited liability. This means sole proprietors can lose their personal assets because of business debts or obligations. It could be essential to consider how risky your business is as you decide on the liability protection that you need.

Why would you choose a sole proprietorship instead of an LLC? A small business owner may worry about the costs or difficulty of forming an LLC. A sole proprietorship is easier and cheaper to create because it's automatic.

Forming an LLC

There are many steps that you must take to form a limited liability company (LLC). One of the first steps is to decide on a name for your legal entity. It could be a good idea to do a search to make sure that the name you want for your company is not already in use.

Another step that you must take is to file articles of organization for your business. The business name and the location of the business should be in the articles of organization. The articles of organization also show the name of the registered agent. A registered agent is a person or company that accepts legal documents for your business.

An LLC operating agreement is another important document. In this document, you lay out the rules for the organization. It can help to have this document if there are any disagreements about management or ownership of the organization. Typically, an LLC owner does not have to file the operating agreement with the state or other agency.

LLC owners must also file annual reports in many states. These compliance rules are governed by state law. Failing to comply can cause your business to lose "good standing" with the state, resulting in fees and other problems.

When you form an LLC, you have to pay a fee when you file the articles of organization with the Secretary of State. Filing fees are different in different states. Your filing fee could be as low as $50, or it could be much higher. There are also annual fees for an LLC in many states. If you choose to use a company for registered agent services, there is a cost for this service, though many people find the price to be worth the benefit they get.

Forming a Sole Proprietorship

If you wish to form a sole proprietorship, you can do so without filing documents with the state. This means that you will not have to pay filing fees. However, deciding on a name for your business is still an essential part of the process if you want to use something other than your name.

In a sole proprietorship, the person's legal name is the business name by default. You may have to do a DBA (doing business as) filing to do business under a different name.

A DBA filing will allow you to do business under a name other than your name. Some sole proprietors choose to use a fictitious business name because it seems more professional. Other sole proprietors choose to use assumed names so that they can keep their personal names private. There is a filing fee for registering a fictitious business name.

Business Structures and Tax Returns

The type of business structure that you choose for your business could affect your income tax. For tax purposes, a sole proprietorship and an LLC are similar. With sole proprietorships and limited liability companies, income passes through the business to the owner's personal tax return.

There is an important difference between the taxation of a sole proprietorship and an LLC. If you are the owner of an LLC, the IRS will let you choose if you want to be taxed as a corporation. If you do not choose to be taxed as a corporation, the IRS will tax your LLC as a sole proprietorship or partnership.

The difference between sole proprietorship and partnership status is the number of members in the LLC. Sole proprietorship status is for single-member limited liability companies. A multi-member LLC will have partnership status under the tax code.

There are two types of corporations that an LLC can choose from for tax purposes: S-corporation and C-corporation. The name for these types of corporations comes from the section of the tax code that covers them. It could be important to note that an S-corp is not a legal entity. An S-corporation is only a status for tax purposes.

For an LLC to be taxed as a C-corporation or S-corporation, the owner must file forms with the IRS. You might be wondering why an LLC owner would want to have S-corp or C-corp status. Some LLC owners wish to have S-corp status because it can save them money. If you are an LLC owner with S-corp status for tax purposes, you may be able to report some earnings as dividends. There is no employment tax on these dividends. This means that you can save on Medicare and other types of taxes.

Considering Forming a Business? A Local Attorney Could Help

You may wish to help decide what type of business structure is right for you and your small business. An attorney could consider your business needs and help you make the best decision. Contact a business lawyer in your area who can help.

Looking to start your own business? Use FindLaw's DIY forms to get a legal business entity set up in minutes.

Related Resources

• Starting a Business
• Start-Up Financing