Limited liability companies are business structures in the United States that facilitate the ability for business owners to limit their personal liability. Choosing how you want to incorporate your business is extremely important. First, you will need to understand the difference between an LLC and a sole proprietorship. Although an LLC can be taxed as a sole proprietorship or a corporation, they are not the same thing. Let’s dive in.
Advantages & Disadvantages of LLC
There are many advantages when it comes to forming an LLC. The amount you will save on taxes can easily pay for formation costs, and you will also have privacy if formed anonymously. Forming an LLC can also seem more professional than a sole proprietorship, as it will be formed under a business name.
The two main advantages that an LLC holds is that you have liability protection. If your business is sued and it is formed in an LLC then you will not need to worry about your personal assets being seized. An LLC also offers tax flexibility, because you elect how you want to be taxed.
Although there are far more advantages than disadvantages when it comes to forming an LLC, the only disadvantage is that typically it can add some complexity to your business and how you file your taxes.
What is a Sole Proprietorship?
Sole proprietorships are often referred to as a sole trader or a proprietorship. These are unincorporated businesses that have a single owner. If you are part of a sole proprietorship then you will only pay personal income tax on any profits earned from the business.
Advantages & Disadvantages of Sole Proprietorship
There are some advantages when operating as a sole proprietor. They are simple to form and really only require you to operate and pay taxes. There is a potential to pay more in taxes due to everything being earned income, but you are not required to pay any specific business taxes or unemployment taxes.
Another disadvantage of a sole proprietorship is unlimited liability. If someone sues your business your personal assets can be attacked. This form of business ownership also looks unprofessional, which can make it difficult to grow or raise money.
What is the Difference Between the Two?
Formation
Typically sole proprietors are a single person that owns a small or a part-time business. Most of the time there will be no employees, and the start-up costs are next to nothing. Starting a sole proprietorship can be as simple and starting work. Although you may need to obtain licenses, permits, and other permissions, you can easily begin work without jumping through the many loops that are required when forming an LLC.
Liability
LLCs are a hybrid of the partnership and corporate forms of business. LLCs allow the liability protection of a corporation with the tax advantages of a partnership. Essentially, LLCs protect you from risk. Any debts incurred by your business as a sole proprietor will be placed on you as an individual. Regardless, you should always hold liability insurance to protect yourself.
Funding
Depending on the type of business you plan to start, funding is always an important factor. If you are starting a small business you may attempt to fund it yourself with a full-time job, but if not, then you may need a business loan. Setting up your business as a separate entity can help you to obtain a loan much easier. Some lenders may not even approve you for a loan if you are the sole proprietor.
LLC & Sole Proprietorship Taxation
Owning and operating a business as a sole proprietor is essentially being taxed as a self-employed person. Any income your business makes as a sole-proprietor is considered personal income, and you will be taxed as so. You may also qualify for pass-through taxation. This can help you to save on your self-employment tax, but your tax rate can vary depending on your business type.
As a sole proprietor, filing taxes is very simple. The current self-employment tax rate is 15.3%, so you will need to pay this on your own. When it comes to an LLC with multiple members, you may be able to cut your tax bill.
When it comes to an LLC, you have choices. You can choose either to be taxed similarly to a sole-proprietor, a partnership, corporation, or s-corp. If you do not make a selection then you will either be taxed as a sole-proprietor or a partnership depending on how many members exist.
Should You Start an LLC or Sole Proprietorship
Many people would tell you that forming an LLC is always the best way to go, but that is not always true. If you will not obtain any significant benefits as an LLC over a sole proprietor, then there is no point in paying extra fees to be an LLC.
It is good to note that in some states single-member LLCs are not look upon favorably. This may be something to consider if you have no other partners. Essentially, the main reason you would want to form an LLC is if you own assets, and have any chance to be sued. If you feel the need to protect your assets, then an LLC is the best way to go. Just be prepared for additional fees, paperwork, and a difference in taxation.