Coming up with a profitable idea might be the first step in starting a business, but it’s hardly the last. There are a lot of administrative tasks that you need to complete in order to get your business up and running, and that includes deciding between a sole proprietorship vs LLC (limited liability company) for tax and legal purposes.
A sole proprietorship and an LLC are both ways to define your business structure and protect your personal interests. But there are quite a few major differences to be aware of when making the choice between an LLC vs. sole proprietor designation, and it’s important to understand what those are.
Here’s what you need to know about how a sole proprietorship vs. LLC will affect the formation and ongoing structural operations of your business—and what might be your better choice.
The Difference Between LLC and Sole Proprietorship
A sole proprietorship is a business owned and operated by one individual. This person has the right to make all of the decisions for the business and keep all of the profits. They also accept all personal risks and liabilities. This type of business is unincorporated, which means that, for legal purposes, there is no difference between the business and the person who owns it.
An LLC, or limited liability company, is legally incorporated at the state level and is considered a separate entity from its owner or owners—known as members. Members share all of the decision-making responsibilities, and it’s the business assets—not individual members’ assets—that are subject to liabilities from debt and other obligations.
Both offer a way to scale your business and operate legally in your state, but there are three primary distinctions when you’re looking at sole proprietorship vs. LLC:
- Who owns the business: A sole proprietorship has a single owner and is considered one and the same as the business. An LLC can have multiple owners, and they are considered separate entities from the business.
- Who takes on the liabilities of the business: In a sole proprietorship, the owner maintains all liability and is responsible for any debts or other financial obligations the business incurs. In an LLC, the business’ assets are separate, and the personal assets of the owner or owners are protected.
- How business decisions are managed: A sole proprietor has the right to make all legal, financial, and other decisions related to the business. In a multi-member LLC, owners must make decisions together unless a single decision-maker is appointed.
In addition, whether you opt for a sole proprietorship vs. LLC will have a direct impact on the process for forming your business and your options when it comes time to pay taxes.
Is a Single-Member LLC the Same as a Sole Proprietorship?
No, they’re two different things. A single-member LLC still serves to separate the owner and the business as individual entities, which a sole proprietorship doesn’t do. Even without additional owners, a single-entity LLC affords legal protections that an individual won’t have with a sole proprietorship and is handled differently in terms of formation, taxation, and other structural concerns.
Set Your Business Up to Succeed
Strategy: Essentials for Management, Consulting, and Startup Success
Benefits of LLCs
Why might someone choose an LLC vs. sole proprietorship? There are a number of advantages that an LLC affords, especially when it comes to risk management. Here are some of the big ones.
If someone sues the company or the business faces any debts, payment can only come from business assets and not the assets of the owner. This is a big advantage for business owners, since assets like their home and personal bank accounts are safe from legal recourse.
When you incorporate as an LLC, whatever name you have chosen officially belongs to you. This means that no other business can open in your state with the same name, providing some protection against direct competitors.
An LLC benefits from pass-through taxation, meaning business income is reported on personal tax returns, and it’s the individual owners who get the deductions. If preferred, though, an LLC owner can choose to be taxed as a corporation instead, giving the flexibility to go with whichever structure offers better terms.
Benefits of Sole Proprietorships
Is sole proprietorship better than LLC? That depends on what benefits matter to you. Here are a few of the main advantages afforded by a sole proprietorship designation.
Easy to Establish
A sole proprietorship doesn’t require much (if anything) to establish. You’ll use your personal social security number on your tax return and will only need to get permits if they’re required for the type of work that you’ll be doing.
Solo Decision Making
Sole proprietors have total control over every single aspect of their business, even if they bring on additional shareholders.
Sole proprietors might not have the flexibility to choose how they want to be taxed, but they do at least have the de facto advantage of pass-through taxation. This includes having all of their business assets taxed only once instead of incurring the standard double taxation of corporations.
Can You Switch From LLC to Sole Proprietorship?
Yes, however in most cases you will have to dissolve your business in order to do so. This requires dividing up the assets among the members and then beginning from square one. Once you start up again, your business will be considered unincorporated and structured as a sole proprietorship, provided you go into business alone.
Can You Switch From Sole Proprietorship to LLC?
Yes. To do so, look into the process in your state for establishing an LLC, since going from a sole proprietorship to an LLC likely won’t be any different than if you just established an LLC from scratch. The only extra step that you might have to take is revising your trade name if you registered it under one entity and want to switch it to another.
Sole Proprietor vs. LLC: Which is Better?
As a business owner, you’re the one who is best suited to make the LLC vs. sole proprietor decision for your company. Both designations come with advantages and disadvantages, the biggest of which are related to ownership rights, taxation, and personal risk and liability.
Probably the most important thing to keep in mind when choosing which one is preferable for you is that under a sole proprietorship, you will maintain complete financial responsibility for any risks that may incur, while an LLC provides a buffer between liabilities and your personal assets. That being said, a sole proprietorship is a lot quicker and easier to establish than an LLC, and depending on the type of business you’re starting, you might not have much liability to worry about in the first place.
Still not sure which way to go? As you pivot to your new career as a small business owner, make an appointment with a financial advisor to see what they recommend based on your business, your finances, and your future goals.
Turn Your Passion Into a Business
Business Behind-the-Scenes: Growing Your Creative Passion
This article is not intended to be financial advice.