Head to Head: sole proprietorship vs LLC - Which Business Structure is Right for You?

Updated: June 7, 2023

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Sole proprietorship vs LLC

Before we fast forward to the decision-making, let’s understand a few basics till then: What is a sole proprietorship? What is an LLC? Are there any benefits or drawbacks to forming them? Are they even different from each other? Lastly, out of the two, which business entity is the right one for your business? Without much ado, let’s get straight down to business,

A Sole Proprietorship, or sole prop, is the simplest business entity or structure out of all. It is an independent business owned and managed by a single person, with no legal separation between the entity and owner. As a sole prop owner, you’d have total control and authority over the business, its income, debts, and losses. In sole props, your profits will be taxed just like your private income, and you’ll be able to do what you intend to do with it. Other company structures have multiple owners and members who share control and decision-making on where the income is distributed.

A Limited Liability Company, or an LLC, is a legal business entity that provides a legal framework for your business venture. It is a famous corporate entity structure that shields its owners and members from legal liabilities. As a result, the owner’s assets are protected from any obligations the company might face. An LLC also offers tax benefits and flexible management alternatives, which appeal to many business owners.

The single member LLC is most similar to the sole proprietorship model and will be the other base of our comparison. A single member LLC has just one owner controlling 100% of the business, the same as a sole proprietor who turns profits while working independently.

Benefits and Drawbacks: Sole proprietorship vs LLC

Both sole proprietorship and LLC have both pros and cons. Let’s discuss some of them so that you can choose better.

Benefits of a sole proprietorship:

Easy Setup: Sole prop is relatively simpler and inexpensive to set up. If you’re the only company owner performing all the business activities, then you’ve already formed this business structure. There is very little processing and paperwork involved compared to an LLC.
Direct Control: A sole proprietor controls all business handling and decisions. They can set their visions, goals, and strategies without consulting or seeking approval from other members or shareholders.
Tax Benefits: Sole prop owners enjoy pass-through taxation, where business profits and deductions are reported on their private tax returns. Also, since the owner and business are single entities, they’re eligible for self-employment taxes, which are long-term benefits.

Drawbacks of a Sole proprietorship:

Unlimited Personal Liability: As a sole proprietor, you’ll be liable for your business losses, debts, and legal implications. If your business faces a financial crisis or legal issues, your personal assets, like your savings, car, and property, will be at risk.
Difficulty in Raising Capital: A sole prop may face challenges in raising capital or securing loans. Lenders and investors often prefer working with more established business entities, like an LLC, than an “informal” sole proprietor program.
Everything depends on you: With no partners or investors to lean on, sole proprietors are on their own and often have to make isolated, complicated decisions.

Benefits of an LLC:

Limited Liability Protection: In comparison to a sole prop which puts your private assets at immediate risk, an LLC model with limited liability protection won’t be held accountable if the business suffers a loss, which keeps owners’ personal belongings, like a bank account, car, safe from being captured.
Flexibility: LLC offers flexibility regarding management, ownership, and tax status. They can be taxed as a pass-through entity or a corporation and owned and managed by one or more people. Also, as a single member LLC, you can choose to be taxed as a sole proprietorship or elect to be taxed as a S Corp or C Corp.
Tax benefits: Regarding taxation, LLCs benefit from the best of both worlds. LLCs can adopt the tax status of sole proprietorships, partnerships, S corp, or C corp but do not have their federal tax classification.

Drawbacks of an LLC:

Cost: An LLC is relatively more expensive to open and manage than a sole proprietorship, which may affect you if you’re on a budget.
Limited Life Span: The existence of a Limited Liability Company is often tied to the presence of its members or owner. If they leave or pass away, the LLC may dissolve unless specific provisions are mentioned in the operating agreement.
State Handling: An LLC has to manage its operations with the state and federal governments and local jurisdictions in some cases, depending on the nature of its business.

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Differences: Sole proprietorship vs LLC

Before you conclude, here are some critical differences between an LLC and a Sole proprietorship.

Ownership : In a sole proprietorship model, only one person is completely controlled, and no other individual or business can get involved. A limited liability company can have unlimited owners and members who can be people, businesses, and foreign entities. An LLC could be termed an extension of a sole prop where no member has greater ownership than the next.
Name : Every Limited liability company in the United States must add “LLC” at the end of their business name. At the same time, there are zero such name-related restrictions and compulsions in a sole prop arrangement. Also, no two LLCs can have the same name.
Limited Liability : As the name suggests, in a limited liability company, the owners and members have limited liability. At the same time, sole proprietorships enjoy unlimited liability as the owner is solely responsible for the business deductions, debts, and liabilities. In times of financial or legal crisis, creditors can seize the owner’s private assets, like their property and vehicles, to meet their debts in a sole prop. This can never happen with an LLC, where the owners and members are protected from lawsuits and creditors related to their business.
Cost : A sole proprietorship is cheaper than an LLC since it only requires initial licensing and processing fees. On the other end of the spectrum, an LLC should be registered with the state and must pay off the annual fees. The total charge to set up an LLC can go around $1000.
Taxation : In sole prop, the owner’s income is considered personal income and taxed accordingly, and in an LLC, the members and business are treated separately, and their taxes are based on business income, not personal income. However, a Limited Liability Company can be taxed as a partnership, C corp, S corp, sole proprietorship, or any other entity. This option enables LLC members to reduce their tax burden. The confusion between an LLC and a sole proprietorship often arises because they can and cannot be taxed similarly.
Difficulty in Raising Capital : A sole proprietorship may need help raising capital or securing loans for its operations as its credibility is low due to the same private and business income. As a result, lenders and investors often prefer working with more established business entities, like LLCs.

Which business structure is the perfect choice for your business?: Sole proprietorship vs LLC

In our expert opinion, since an LLC offers more tax benefits and protects your private assets and personal property, it’s a much better choice than a sole proprietorship if you have enough resources to handle the fees and administration.

An LLC offers tons of perks for entrepreneurs like you,

Distinct legal identity
Limited Liability
Pass-through taxation
Tax advantages
Versatile Ownership
Permanent existence
Flexible management
Credibility
Flexibility in profit sharing
Inexpensive to form

Final Word: Sole proprietorship vs LLC

If you’re an entrepreneur planning to go solo or a “solopreneur,” you need to decide between choosing an LLC as your business setup or sticking with a basic sole proprietorship program.

The choice ultimately depends on your personal circumstances, preferences, and business kind. A sole prop offers lower costs but exposes you to personal liability. At the same time, an LLC provides limited liability protection, tax benefits, and flexibility but involves a lot of paperwork and big budgeting.

Consulting with lawyers and tax professionals will help you make an informed decision that aligns with your goals and provides your business with legal and financial security.

Lastly, whether you form an LLC or go down the sole prop route, transforming your idea into an official and reliable empire is entirely up to you and your dedication.

Frequently Asked Questions

Is a sole proprietorship the same entity as a single member LLC?

They are not the same entities, despite their similarities. The critical distinction is that a sole proprietorship doesn’t provide limited liability protection for the owner, whereas a single-member LLC does.

Do I require an LLC if I am self-employed?

Although you don’t need an LLC if you work for yourself, we advise doing so because of its benefits over a sole proprietorship.

Are there any advantages to forming an LLC?

Of course! There are numerous benefits to forming an LLC. Some of them are:

Distinct legal identity
Pass-through taxation
Limited Liability
Permanent existence
Flexible management

Are you still confused? Here’s a detailed read regarding the same.

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