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mong the many decisions you'll make when you become self-employed is what business structure to choose. Is it better to run your business as a sole proprietorship or form a limited liability company (LLC)? Both options have benefits and drawbacks, so the decision isn't necessarily clear-cut whether you freelance or have employees. The answer may lie in how you prefer to manage your business and whether it makes sense to separate your business and personal assets. 

What is a Sole Proprietorship?

A Sole Proprietorship is an unincorporated business owned by one individual. A sole proprietorship can run under a trade name (DBA) or a fictitious name, but using another name isn't required and can be done under the individual's name. 

Sole proprietors include freelance workers, independent contractors, gig workers, and other self-employed individuals. A sole proprietor can also have employees, like other business entities, and are required to pay wages, file and submit payroll taxes, and follow federal, state, and local employment regulations. 

As a sole proprietor, an individual is responsible for everything related to the business, including profits and losses, debt, and legal responsibilities. The IRS views an owner and their business as one entity. 

It's one of the most straightforward business structures because there's far less paperwork involved than in forming other business structures. No separate business tax return is required. Sole proprietors report business income and additional pertinent information with their personal income tax return each year, paying self-employment taxes on their profits. Unless you plan to do business under another name, there is no need to register a sole proprietorship business with the state. If you plan to use another name, you must follow state guidelines for registering your business. 

Pros

  • You're the boss: There's no need to get approval for any business decisions as a sole proprietor. It all starts and ends with you. You can control your business as you see fit and pivot as needed to fit your needs. 
  • Simplicity: Sole proprietorship is the simplest business structure in terms of paperwork. There's also no need to file a separate business tax return. You also don't need to obtain an employer identification number (EIN) and can instead use your Social Security number (SSN).
  • Fewer fees: Many business structures, including LLCs, require you to register your business and pay annual fees with the state in which they are formed. That's not the case as a sole proprietor, which doesn't require you to register or pay costly fees. 

Cons

  • No protection: There's no separation between personal and business assets, and you're responsible for all business debts and other obligations. Creditors can legally go after personal assets to recover debt and losses tied to your business. 
  • One tax option: LLCs have the option to be taxed in several ways, such as an S-Corporation or C Corporation, to potentially save money. Sole proprietors fix personal and business taxes together. 
  • Fewer financing options: LLCs generally carry more weight (and trust) with banks and other lenders. Sole proprietors may struggle to qualify for financing, including business loans and lines of credit. The only option that may be available is to take out a personal loan for your business. 

What is an LLC?

A Limited liability company, or LLC, is a legal business structure in the U.S. that protects its owners from personal responsibility for business debts and other liabilities. LLCs combine the protections of a corporation with some of the simplicity of a sole proprietorship, although you must register an LLC within your state. 

LLCs can have one owner. These are known as single-member LLCs. They can also have an unlimited amount of members. These members manage the LLC or can appoint one individual to manage day-to-day business operations. Generally, members create an operating agreement that lays out how the business will run. 

Members of an LLC are required to file articles of organization with the state where they will operate. Articles of organization include details such as the business name, the registered agent, business address, names and signatures of all members, and other business details. Requirements and fees vary between states. 

You can file for an LLC through your state, typically through the Secretary of State or another state agency. Several steps go into getting an LLC. It all starts with creating a name for the business, which must include the words Limited Liability Company, LLC, or L.L.C. Other steps may include:

  • Selecting a registered agent (or statutory agent) 
  • Obtaining a business or vendors license, if required by the state
  • Filing Articles of Organization
  • Creating an operating agreement
  • Get an Employer Identification Number (EIN)

Once approved, the state will issue you a certificate confirming the formation of your LLC. The process may vary depending on the state where you file.

Pros

  • Added protection: Operating as an LLC limits personal liability if you struggle with debt and other issues with your business. Unlike a sole proprietorship, creditors will have a more challenging time pursuing personal assets if you operate as an LLC. 
  • Flexibility: LLCs can be single-member or have multiple members, each able to receive benefits larger than as an individual owner.  
  • Tax benefits: You can potentially save money as an LLC by being taxed as an S-Corporation or C-Corporation.

Cons

  • Fees: You must pay a fee when registering an LLC. You are also on the hook for an annual or biannual fee to maintain your LLC status in your state. Depending on the state, you may also be required to pay a franchise or capital values tax. 
  • Complex tax returns: You will have to file two tax returns, a personal return and a business owner's return, if your LLC is taxed as a corporation
  • More complex structure: The structure of an LLC is much more involved than a sole proprietorship, especially if there are multiple business owners. 

Sole Proprietorship vs LLC: Which one is best? 

Whether you've already started your own business or are planning to do so soon, understanding and choosing the proper structure can help shore up important details about your business. If you're starting, a sole proprietorship might make more sense since there's not much you need to do other than start doing business. Switching to an LLC or other business entity will provide more flexibility and protection for personal assets as your business grows. Ask yourself the following questions while determining the best course of action. 

  • Is it your own business, or do you share ownership with someone else? You can't be a sole proprietor if there's more than one owner or member. 
  • Do you have personal assets that you don't want to be mixed with your business assets? Your house, car and other assets may be fair game if you carry business debt and have no way to pay it back. Getting an LLC might be worth any registration or annual fees.
  • Do you plan on growing your business and adding more employees soon? You can still hire employees as a sole proprietor, but as your business grows, switching to an LLC provides more liability coverage. 

Seek out legal advice to help determine the best business structure for your needs. If you're thinking of incorporating your business, Novo can help. Novo has partnered with LegalZoom to save you time and money forming your business entity.

Updated 
November 9, 2022
 in 
Business Building
 category