Trying to decide between a sole proprietorship vs. LLC for your new business? It is important to choose the right legal structure for your company because the structure will determine how you are taxed, what level of control you have over your business and how much liability you incur.
This article explains the differences and pros and cons between a sole proprietorship vs LLC. In a related article, we provide more information on corporations, partnerships, and other types of business legal structures.
Sole Proprietorship
The sole proprietorship is the easiest of all legal business structures. The owner is responsible for the actions and debts of the business. You don’t have to deal with a lot paperwork, as you do not need partners or a board. This is a good option for entrepreneurs who want to start out small and don’t expect to have additional investors or partners. The sole proprietor has complete control of their business and can remove themself as owner at any time.
The sole proprietorship is a good choice for many other reasons. The cost of setting up a sole proprietorship is usually the lowest. You can expect to pay for state and federal taxes, business equipment and office space rentals, as well as any professional services and items that your business may require, such as attorneys, bookkeepers and cleaning services.
You may qualify for certain business tax advantages as a sole proprietor, including the ability to deduct your health insurance premiums. If you want to close your company, it is relatively simple to dissolve a sole proprietorship. Your business can be dissolved at any time without the need for paperwork or an announcement.
The Downside of Sole Proprietorship
A sole proprietorship has its own downsides and risks. Unlimited personal liability is a major concern, which means that your personal assets could be at risk in the event of financial difficulties or lawsuits.
Another downside is the limited access to resources and capital. Due to the perception of instability, it may be difficult for sole proprietors to attract investors or secure financing. This could hamper business growth and reduce competitiveness. Due to the perception of instability, it may be harder to recruit top-tier partners or employees. This can also limit growth.
Limited Liability Company (LLC)
The LLC offers both flexibility and protection. It is also a popular option for the legal structure of an enterprise. The LLCs protect you against personal liability, and offer tax flexibility that is similar to sole proprietorships or partnerships. Owners (called members) pay self-employment tax on their profits. This can be more than the regular payroll tax. Depending on the location of the business, LLCs can have limitations on the length of time the company may exist. Members must also be US citizens or permanent residents.
As with limited partnerships, an LLC protects its owners from liability for company debts and legal actions. If your company is sued, you cannot use your assets. In addition, LLCs offer flexibility in terms of management and ownership. Members can choose whether the company will be managed by them or by managers appointed by the members. The structure of LLCs is flexible, allowing for a variety of business types and sizes.
Dissolving an LLC is more difficult than dissolving a sole proprietorship or partnership. This can require compliance with state regulations, and may result in additional costs. Limited liability may be a great advantage but it can also have a downside if members personally guarantee loans. This could happen when a business is starting up and does not yet have a business credit score or is a sole-proprietorship. Some states charge an annual fee for LLCs or levy a franchise tax, which can increase the cost of running the business.
Each type of legal structure will have its own pros and cons. Therefore, it is important to research the different factors and make sure you know all the details when you are choosing between a sole proprietorship vs. LLC. Consult with tax, legal and financial professionals to make informed decisions that are aligned with your business goals while minimizing risks.
