Sole Proprietorship vs. LLC

Two popular options among new business owners are sole proprietorships and limited liability corporations (LLC). Which one you choose will impact the steps you need to take to start your business and the ongoing requirements for running it. It will also affect the extent of your personal liability and your business’s tax treatment.

See below for all you need to know about starting a sole proprietorship versus an LLC to determine which best fits your needs.

Sole proprietorship vs. LLC explained

A sole proprietorship refers to a single-owner business where the owner isn’t treated as a separate legal entity from the business. Under this structure, the owner keeps all business profits, but is also completely responsible for its debts.

Sole proprietorship is perhaps the simplest structure you can have, and you can get started immediately without many formalities.

So, what is an LLC, on the other hand? This type of business provides limited liability protections for your personal assets like a corporation. This means its accounts and debts are separate from your own and, if the LLC could not pay its expenses, creditors could only go after the LLC’s assets, not your personal ones.

Starting an LLC requires registering with the state and designating the members who will run it.

Both sole proprietorships and limited liability companies make suitable structures for single-owner businesses, and, before making a decision, it’s important to understand the pros and cons to both.

Sole proprietorship

A sole proprietorship is a business you own and don’t have to formally register with the government in a particular way.

This popular choice for single-owner businesses offers simplicity in starting and operating the business. You’ll control all aspects so you can make daily business decisions, keep all profits and even change the business’ direction as you’d like. In addition, you can still hire workers like you could with a more formal structure.

Formation documents needed

A sole proprietorship doesn’t require any state document to start the business. Instead, you start the business by simply providing work for clients.

However, if you plan to use a trade name, your county or state may require filing a fictitious business name statement with your desired business name. You’ll first have to confirm availability for the name and check any restrictions on allowed business names. For example, your business name can’t include “corporation,” “LLC” or similar terms implying a different business entity type. You can consult your state or county for the list of disallowed terms.

You’ll also want to know if you need any licenses or permits for your type of work. For example, running a food service business might require licenses from the health department, food handling safety certifications, among other requirements. Obtaining these means meeting all requirements, submitting paperwork and, of course, paying fees.

Registration and filing fees

You usually don’t have to register with your state to operate as a sole proprietor. However, you’ll pay a nominal fee if you register a fictitious business name. The amount of the fee depends on the state. For example, the state of Washington charges a $5 filing fee for fictitious business names, while the state of Florida charges $50.

Depending on your line of work, you may also need to pay for business license and permits. These can include occupational licenses, operational licenses, zoning permits and sales tax permits. You’ll want to check with local, state and federal authorities to determine your requirements and costs.

Taxes and business expenses

As a sole proprietor, you wouldn’t need to file a separate business tax return; instead, you’d list your business income and deduct business expenses on your state and federal personal tax returns. Your business income gets taxed at your usual individual income tax rate. You’d also pay self-employment tax, which covers the employee and employer shares of Medicare and Social Security taxes.

You’d also need to pay estimated taxes to the tax authorities each quarter. This means estimating your annual income, so you don’t come up short. Otherwise, you could owe taxes and penalties when you file your return.

You can use your Social Security number as your tax ID as a sole proprietor. However, consider getting an Employer Identification Number (EIN) from the IRS if you want a business-specific number. An EIN offers more privacy than your Social Security number, boosts your business’s credibility and is required if you hire workers.