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Sole proprietorship vs LLC: What’s the difference?
Learn which business entity type is best for your company.
A sole proprietorship treats a business owner and the company as the same legal entity. This arrangement is easy to set up, but sole proprietorship passes personal liability to the business owner. On the other hand, an LLC provides more protection from liability but is often more complex and expensive to run.
If you’re trying to choose between an LLC or a sole proprietorship, both options have pros and cons. In this guide, we’ll weigh the difference between sole proprietorship vs LLC and help you determine which business structure is right for you.
What is a sole proprietorship?
A sole proprietorship is a business entity that one person owns and runs. With this setup, no distinction exists between a micro-entrepreneur and their business. As a sole proprietor, the owner is entitled to all profits from the business but is also responsible for all of the business’s liabilities.
Sole proprietorships have several characteristics:
Easy to set up and run.
Setting up a sole proprietorship is cost-effective and straightforward, often requiring minimal legal paperwork and administrative red tape. You can often start your business as soon as you’re ready to operate. With fewer regulations and less paperwork than other business structures, a sole proprietorship can be more straightforward and less bureaucratic than an LLC.
Greater control.
As a sole proprietor, you have complete control over all business decisions. If you prefer to manage every aspect of your business independently, a sole proprietorship offers much more autonomy.
Tax benefits.
The IRS doesn’t tax a sole proprietorship separately. Instead, the business reports all income and expenses on the owner’s tax return. Tax season is much simpler with this setup, streamlining the filing process and potentially reducing your tax burden.
Liability concerns.
One big drawback to running a sole proprietorship is that you’re on the hook for business liabilities and debts. Your personal assets are at greater risk if your company goes into debt or faces legal trouble.
Nearly 87% of nonemployer businesses (companies without employees) are sole proprietorships, making this the most popular type of business structure.
A sole proprietorship simplifies your business, but you can’t do everything alone. That’s why so many sole proprietors rely on tools like Adobe Acrobat for business. Easily create, edit, and share essential business documents, contracts, and invoices with Acrobat’s helpful PDF tools. With features like e-signatures, you can quickly sign approvals and agreements, saving time and improving workflow efficiency.
Advantages and disadvantages of sole proprietorships.
Sole proprietorships are popular because they’re easy to set up and manage. If you’re a first-time business owner, this simple option allows you to learn the ins and outs of running a business on your terms. When you think of the difference between sole proprietorship vs LLC, the first is pretty straightforward, with minimal paperwork and low start-up costs. Additionally, you’ll experience fewer regulatory hurdles compared to other business structures.
One of the many advantages of sole proprietorship is that the IRS considers this structure as a pass-through entity, which allows you to declare business income on your personal tax return. You also have direct access to the company’s profits as an owner draw, allowing you to potentially earn more personal income through the business.
However, sole proprietorships have their downsides. As the sole decision-maker, you oversee all business responsibilities, which can be overwhelming. These tasks include managing finances, marketing, operations, and compliance. You could also lose your home, savings, car, and other assets if the business faces financial difficulties or lawsuits.
What is an LLC?
A limited liability company is a type of business that combines the benefits of a corporation’s limited liability with the tax advantages of a sole proprietorship. LLCs are more popular with small business owners who plan to grow their company’s footprint, whether in terms of physical space, employees, or revenue.
LLCs offer:
Greater protections.
Many business owners choose an LLC structure because it offers additional protection. Members are not personally liable for the company’s debts or liabilities, so their personal assets, such as homes and savings, are generally protected from business-related lawsuits and creditors.
Pass-through taxation.
Like a sole proprietorship, an LLC offers pass-through taxation. Profits and losses are reported on individual members’ tax returns, allowing you to avoid the double taxation of organizing as a corporation.
Relatively simple setup.
Forming an LLC involves less paperwork and regulatory requirements than forming a corporation. However, it typically requires more formalities than a sole proprietorship, such as filing articles of organization with your state.
Multimember options.
You can use an LLC structure for various businesses, from single-owner operations to larger companies with multiple managing members. It offers more flexibility than a sole proprietorship, which is helpful for organizations with long-term growth goals.
Advantages and disadvantages of LLCs.
The biggest advantage of filing as an LLC is greater protection of your personal assets. LLCs also enjoy the pass-through tax benefits of a sole proprietorship, potentially avoiding double taxation.
LLCs are also very flexible. You can either manage the business yourself (member-managed) or hire a manager to oversee things for you (manager-managed). Compared to corporations, LLCs have fewer formal requirements, such as not needing to hold regular board meetings or maintain extensive records.
However, forming an LLC vs a sole proprietorship requires more money. Expect to pay filing fees, legal fees, and ongoing costs like annual report fees. While less complex than a corporation, an LLC is still more complicated to set up and maintain than a sole proprietorship. You must draft an operating agreement and stay compliant with state regulations for LLCs.
Setting up an LLC includes tax advantages, but you’re considered self-employed as an LLC member. You’re required to pay self-employment taxes on your share of the business income, including Social Security and Medicare taxes.
Running a business as an LLC vs sole proprietorship.
Choosing between a sole proprietorship vs LLC is a pivotal decision for any business owner. Each structure has implications for personal liability, taxation, and day-to-day operations. Weigh the difference between LLC and sole proprietorship to choose the best structure for your company.
Formation and management
Sole proprietorships are easier to establish and maintain. They promote minimal paperwork and no formal registration required with your state — minus any necessary permits, business licenses, or local regulations.
LLCs, on the other hand, require more formalities, paperwork, and fees. Because of these documentation requirements, you can expect higher setup fees and ongoing maintenance costs.
The legal structure also affects your company's day-to-day management. As a sole proprietor, you have total control of all decisions, while an LLC owner must work more collaboratively with other members or managers.
Regulations and compliance
Sole proprietors don’t have to submit nearly as much paperwork or comply with as many regulations as LLCs. They don’t have to submit annual reports, either.
LLCs must comply with more requirements, including listing a registered agent and holding regular meetings. The good news is that this structure is still less formal than a corporation, allowing LLCs to operate with less red tape.
Personal liability
The biggest difference between a sole proprietorship versus an LLC is personal liability. You’re liable for business debts and legal obligations as a sole proprietor. Your personal assets, including your home, could be used to settle business liabilities.
LLC members aren’t personally liable for debts or lawsuits, as their assets are protected from business-related risks. Creating an LLC is more complex, but many business owners use it to safeguard their personal assets, especially if they run higher-risk businesses or have high-value assets.
Taxes
Both sole proprietorships and LLCs are pass-through entities, meaning owners can report income on their tax returns. Both structures also require self-employment tax payments on net income. However, LLC members can choose whether to tax the company as a partnership, S corporation, or C corporation, so they have more opportunities for tax optimization with this setup.
Frequently asked questions.
Is it better to start as an LLC or sole proprietorship?
Sole proprietorships are more straightforward and less expensive, making them a better choice for small, low-risk businesses. However, an LLC is better to guard your assets against business debts or liability. LLCs shield personal assets and offer more tax flexibility, although they’re more complex and expensive to manage.
What are the disadvantages of a sole proprietorship?
The biggest downside to a sole proprietorship is personal liability. You’re liable for all business obligations, which puts your assets at risk if the business incurs debt or faces legal issues. Sole proprietors are also solely responsible for running their businesses and often face challenges raising capital from inventors.
Is an LLC taxed like a sole proprietorship?
If it has a single member, yes. In this case, the IRS treats the LLC as a disregarded entity, where the owner declares all income and expenses on their personal tax return. However, tax rules will likely differ if the LLC is a partnership, S corporation, or C corporation.
Should I convert my sole proprietorship to LLC?
Converting a sole proprietorship to an LLC will reduce your liability, simplify raising capital, and give you more tax flexibility. However, LLCs come with additional costs and complexity. Consult with a legal or financial advisor to make the best decision.
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