So you want to start a business? Or… so you already started a business? Or you want to start a business or you already started a business and aren’t sure what business entity is best?? Well I’ve got you covered today! Today I’m going to chat about the difference between two of the most common business types for small business owner – being a sole proprietor or forming an LLC. Which is right for your business and you? We’re going to get into that right now! Get your thinking caps out and join me.
What is a sole proprietorship?
A sole proprietorship is the easiest business form. It’s where you are running an unincorporated business by yourself and there is no legal distinction between the you and your business. This means that you get all of the profits, but you are also responsible for all of the business’s losses, debts and liabilities.
How do you create a sole proprietorship?
You don’t need to affirmatively do anything in order to form a sole proprietorship. So if you are making money right now with your blog or business and you haven’t filed anything in order to create your business, then congrats – you’re already a sole proprietor! Once you are doing business activities and you are the only owner, then you are automatically a sole proprietor.
However, you may need to obtain certain licenses or permits, depending on the work that you’re doing, the industry you’re in and where you are located. You can search here for licensing and permits for your particular business.
You can operate your business under your own name, but you can also decide to file a fictitious name (also known as an assumed name, trade name or “doing business as” (DBA) name). You must choose an original name that isn’t already being used by another business.
When you’re a sole proprietor, you and your business aren’t separate legal entities. Therefore, the business isn’t taxed separately, meaning that any income you earn in your business is personal income. Therefore, you file your business’s taxes along with your personal taxes. When you file your personal taxes, you will also file your income, losses and/or expenses with a Schedule C along with your usual Form 1040. It is your own responsibility to withhold and pay all income taxes, including self-employment tax and estimated tax.
Related Post: Is Your Blog a Business or a Hobby?
A sole proprietorship is easy and cheap to form – it’s the easiest business type to establish and there are little to no costs.
Since you’re the sole owner, you have total control over any business decisions.
Taxes are easy to do since you file the businesses taxes right along with your personal taxes. The tax rates are also low.
You have unlimited personal liability since there is no legal distinction between you and your business. This means that you can be held personally liable for the debts and obligations of the business. You are also open to liability through lawsuits.
As a sole proprietor, it’s totally up to you to raise money for your business. You can’t sell stocks (like you could in other business types) and it can be difficult to find investors or funding through a bank.
Lastly, in a sole proprietorship, it’s all on you. It’s nice to have total control, but you also have all the responsibility on your shoulders.
Psst! Want to save all this info to refer back to later? Download a free Info Sheet on Sole Proprietors vs. LLC’s by entering your info below!
What is an LLC?
LLC is short for “limited liability company.” The main benefit of creating an LLC is that “limited liability” thing – it means that the business is separate from you as an individual (unlike in a sole proprietorship). Therefore, for the most part, your personal assets are protected against losses, debts or liabilities. For example, if the LLC gets sued or goes bankrupt, the creditors can’t come after your personal assets because the LLC (not you) is the entity that owes them. This can be a great advantage if you are worried about whether you might open yourself up to liability in your business.
An LLC is often a better option than a corporation because it’s easier to form an LLC and you can still get the tax benefits of having a sole proprietorship. You can own the LLC by yourself or with other individuals. The profits and losses of the LLC “pass through” the business entity and the individual owner (or owners) is then taxed on her personal tax filing. An LLC is not seen as a separate tax entity, so the business itself isn’t taxed. The federal government doesn’t tax income on an LLC, but some states do so be sure to check with your state’s income tax agency.
Because an LLC isn’t recognized by the federal government as a separate taxable entity, LLCs must actually file as a corporation, partnership or sole proprietorship tax return. Some LLCs are automatically classified and taxed as a corporation by federal tax law, but those that aren’t can choose their business entity classification (by filing Form 8832). If you created an LLC and you are the only member, you would file just like a sole proprietor (Schedule C on Form 1040). There are different forms if you are filing as a partnership or a corporation. Check out the IRS guide to LLCs for more on tax forms.
Lastly, it is possible to request S-Corp status for your LLC, which requires a special election with the IRS to be taxed different. You can contact a local attorney for help deciding if this is right for you. This can be benefit because the LLC still has limited liability, but for tax purposes it can be treated as an S-Corp. If you want to go this route, contact your state’s income tax agency to inquire about tax requirements if they recognize elections such as the S-Corp.
How do you set up your business as an LLC?
The procedures for forming an LLC vary slightly by state, but there are some general principles that apply. Research your state to see if there are different requirements.
You must choose a business name that is unique in your state, include an indicator that it’s an LLC (such as including “LLC” or “Limited Company” in the name) and it must not include words restricted by your state (such as “bank” or “insurance”). You will file with your state’s Secretary of State (or possible a different office in your state), fill out a form and pay a fee.
An LLC should also have “articles of organization,” which is a simple document that includes information such as your business name, address and the names of the LLC members. Most states require you to file the articles with the Secretary of State, but some states might require filing with a different office. Check with your state to check on the requirements.
An operating agreement is a document that structures the finances and organization of your LLC, in order to provide rules and regulations for smooth business operations. Most states don’t require an operating agreement, but it is highly recommended if you have a multi-member LLC. This document can include things such as ownership interests, allocation of profits/losses, member responsibilities, etc.
Once your business is registered, you will need to obtain any necessary business licenses and permits. Check your state and localities regulations to determine if you need licenses or permits for your business.
If you are hiring employees, make sure that you are following all federal and state regulations for employers.
Lastly, some states (including Arizona and New York) require an extra step of publishing your LLC formation in a local newspaper. Check with your state for specific requirements.
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The major advantage of the LLC is that you are protected from personal liability, so if the LLC gets sued or incurs debts, you personal assets are usually exempt. (There are some exceptions where you can still be personally liable.)
An LLC requires less record keeping and there are less start up costs as compared to a traditional corporation.
Profit sharing within an LLC is much easier than within a corporation. If you have other LLC members, you can decide amongst yourselves how to split up responsibilities and profits.
Setting up an LLC requires more time and effort than establishing yourself as a sole proprietor. You may need to consult with an attorney in order to ensure the best tax benefits.
Members of an LLC are considered self-employed and must pay their own self-employment and income taxes.
If you have an LLC with other members, many states will dissolve the LLC if a member leaves. Therefore, if you have an LLC with other members, it can be difficult if one of you decides to leave.
So, what’s right for you?
Well it depends on lots of factors. (This is a classic lawyer answer – “well it depends…”) But here are some things to take into consideration.
If you feel you may be open to liability, an LLC is a good idea. For example if you are running a brick and mortar business and there is a possibility of accidents leading to a lawsuit, having limited liability is a good idea.
Some people might form an LLC because they think that it will make their business to look more “professional.” This is a personal choice – a sole proprietorship is a real business too (and you can choose a “doing business as” name if you want). Decide if you want that added protection of having your business separate from yourself.
Money is always a consideration. Forming an LLC can cost more money as compared to a sole proprietorship, so do a cost/benefit for yourself. There are can be some tax benefits of forming an LLC – consult with a tax professional or attorney to get more info on your personal situation.
Consider the time factor. Being a sole proprietor is a time saver since you don’t need to file anything. Filing an LLC can be a little more time consuming, so decide if that’s worth it to you.
Lastly, if you do nothing at all, you are already a sole proprietorship. But you can always change to an LLC at a later date. So really, it’s all about figuring out if you want to go from a sole proprietor to an LLC and file the necessary paperwork.
Now this is all A LOT of information. You might not be ready to figure out if you want to change your sole proprietorship into an LLC or what type of business you’re going to start. That’s why I created a freebie for you on the differences between sole proprietorships and LLC’s – to get yours just enter your info below!
Anything you’re still confused about when it comes to these two business types? Are you a sole proprietor now or have you filed to form an LLC? Thinking of forming an LLC? Let me know in the comments! Also if you know anyone who might benefit from this post too, just get clicky over there on the left hand side with the social share buttons – thank you!
Want to learn even more about business entities, including how corporations compare to sole proprietorships and LLC’s? Check out my Quick Guide to Business Entities to learn more!
Disclaimer: I am an attorney, but I am not your attorney. The information in this article is for general informational purposes only and is not legal advice. This article does not create an attorney-client relationship. The author is not liable for any losses or damages related to actions of failure to act related to the content in this article. If you need specific legal advice, consult with an attorney who specializes in your subject matter and jurisdiction.