Sole proprietorship vs. LLC: What’s the difference?
One of the most important decisions new business owners must make is choosing the right business structure. This decision can impact various aspects of your business, including taxes, funding opportunities, and initial costs. With options ranging from LLCs to C-Corps, and public or privately traded entities, the choices can seem overwhelming.
To help you make an informed decision, we will compare sole proprietorships and Limited Liability Corporations (LLC) in terms of tax implications, liability, and cost. Each structure has its own advantages and disadvantages, and by understanding these differences, you can make a more informed choice for your business.
Sole proprietorship: the basics
A sole proprietorship is the most basic business structure, in which a single individual owns an unincorporated business. If you sell goods on platforms like Etsy, you are considered a sole proprietor by default, unless you choose to incorporate your business.
One of the main characteristics of a sole proprietorship is that there is no legal separation between the business entity and its owner. This means that the owner is fully responsible for any actions or debts incurred by the business. Because there is no formal corporate structure, the owner’s personal and business activities are not legally separate.
In addition, a sole proprietorship automatically becomes a corporation as soon as it starts selling goods or services for profit. For example, if you sell services, you are considered a sole proprietor from the moment you start doing business.
Limited Liability Corporation (LLC): the basics
On the other hand, a Limited Liability Company (LLC) is a more complicated business entity. In an LLC, the business is separate from its owner(s), providing a level of protection where the owners are not personally liable for the debts or actions of the business.
In addition, an LLC offers a more sophisticated business structure than a sole proprietorship. It can have multiple owners (called members), managers, and shareholders/investors. This flexibility allows for different ownership and management arrangements, providing more options for financing and operational decision-making.
Key differences
Now that we’ve covered the basics of each structure, let’s delve into their key differences in terms of tax implications, costs, liability, and structure.
Tax implications
As previously mentioned, because there’s no distinction between a sole proprietorship and its owner, taxes are filed the same way. As a result, your personal tax rate won’t be affected whether you’re a sole proprietor or not. However, you may be able to deduct certain expenses from your gross income to reduce your tax liability.
For example, if you are a data analyst working out of your home, you may be able to deduct some of your home expenses, such as utilities, from your income. It’s important to note that if your business generates more than $400 in annual profit, you’ll be required to file self-employment taxes, which are part of your Form 1040, Schedule C.
In contrast, LLCs are separate entities from their owner(s), resulting in separate tax filings. In addition, LLCs offer different filing options. Even as an LLC owner, you have the flexibility to choose to file taxes as a corporation, allowing you to make strategic decisions to take advantage of significant tax benefits.
Cost
Sole proprietorships do not have any specific start-up costs, as they are automatically created when goods or services are sold. The only potential expense may be if you choose to register a business name. In general, the lack of fees associated with a sole proprietorship is a significant advantage.
In contrast, there are certain costs associated with forming an LLC, typically a few hundred dollars, and there are also recurring annual fees. Startxpress is a recommended platform for forming a new LLC because it offers a simple and cost-effective solution to the process.
Liability
The main difference between sole proprietorships and LLCs is the liability of their owners.
In a sole proprietorship, there is no legal separation between the business and its owner. As a result, the owner has unlimited personal liability. If the business faces a lawsuit or financial obligation, the owner is responsible for paying any claims and fees from his or her personal assets. This means that personal property and funds could be seized to satisfy these obligations.
On the other hand, LLCs are separate legal entities from their members. If an LLC is sued or has to meet financial obligations, only the business itself is responsible, not the individual owners. Personal assets are usually protected unless the owner has signed a personal guarantee.
In addition, an LLC can provide liability protection for mistakes made by employees. For example, if an employee of an LLC-owned construction company causes significant damage to a customer’s home, resulting in a lawsuit, the owner’s personal assets are protected. This is because the liability rests with the LLC and its employees, not the individual owner.
What about C-Corps?
If you are considering the ideal structure for your business, you may have come across the term C-Corps. C-Corps differ from sole proprietorships and LLCs in several ways.
Unlike sole proprietorships and LLCs, which are taxed at the individual level, C-Corps are subject to corporate taxes at both the state and federal level. In addition, C-Corps have the ability to issue stock, which can make them more attractive to founders seeking investment opportunities.
To learn more about the differences between LLCs and C Corps, click here.
Takeaways
In summary, sole proprietorships and LLCs have distinct differences. It is important to thoroughly understand the advantages and disadvantages of each option and evaluate how they fit with your specific circumstances.
If neither structure appeals to you, a C-Corp may be a more appropriate business structure for your needs.
For more details, check out the Startxpress Help Center and Blog. If you need assistance, contact us at support@startxpress.io! We’re here to help make managing your business as smooth as possible.
Related Articles
- How are LLCs taxed?
- LLC vs. C-Corp: How To Choose What’s Best For You
- How to Dissolve Your LLC or Corporation
- Wyoming C-corp or Delaware C-corp
- What are the benefits of Wyoming LLCs?
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