Choosing the right business entity is one of the basic things to do while starting a new business. When it comes to small businesses, sole proprietorship and LLC are the major options to choose from. But most business owners it is often confusing to choose what is best for their business. It is important to choose the right business entity as it defines the legal structure, taxes, risks, and so on.
So, if you’re starting a new business or working on freelance gigs you find yourself often wondering what to choose, A sole proprietorship or LLC. Make sure you do enough research and choose the right entity for your business.
What is Sole proprietorship?
Starting a sole proprietorship is the simplest and least expensive business entity. It is an unincorporated business with a single business owner. Anyone who runs the business on their own can be defined as a sole proprietor. Freelancing, running an online business, retailer, consultants, etc. Any business which is run by a single owner and hasn’t set up any formal business structure will be a sole proprietorship by default.
As a sole proprietor, you are responsible for all the liability of your business including debts and other obligations as there is no legal separation between the business and business owner. Most people who run a sole proprietorship use their name as the name of the business. Although, a brand name can also be used by registering it as a DBA (doing business as).
What is an LLC?
LLC or Limited Liability Company is a separate legal entity that is registered under state law. An LLC can have multiple owners, it combines all the features of a sole proprietorship, partnership, and corporation. Since LLC is a separate legal entity, it offers financial and legal protection to its owners. The owners of an LLC are called members. The business structure and role of each member are mentioned on its legal documents or operating agreement.
Creating an LLC can be more complicated than creating a sole proprietorship. Most small business owners who register their business as an LLC aim to protect their personal assets if anything goes wrong. If your business faces a lawsuit, only the assets of the LLC would be at risk, not your personal assets.
Difference between a sole proprietorship and an LCC.
There are various factors that differentiate sole proprietors and LLCs. Some of the key factors there.
Cost for filing your business
If you plan to start your business as an LLC you need to pay a government filing fee which can vary from state to state. This process usually takes a few weeks in most cases. But starting a sole proprietorship has no costs. But you have other costs like insurance, managing your tax withholding, etc.
Getting credits and loans
If your business is seeking credits and loans LLC would be the best option. You can offer an ownership interest of your business as collateral to get more financing whereas the sole proprietor cannot offer its own since the entity has a single owner. You will be liable for all the credits and loans personally, not the business.
A sole proprietorship is strictly owned by one person. An LLC can have multiple owners or members, they can also include other LLCs, corporations, partnerships, trusts, etc. as their owners.
Both LLC and sole proprietors are subjected to reporting their business income on a Schedule C along with their tax return. A sole proprietor can deduct his business expenses that are allowed in this form and the tax benefits would be deducted from the owner’s net income.
LLC with a single owner will be taxed the same as a sole proprietor. If the LLC has multiple owners, each member has to report their share of business income on a Schedule K-1 form along with their personal income tax returns.
Note: All business has to pay payroll taxes, state and local sales taxes, self-employment taxes to cover their social security and Medicare, or any other additional taxes.
Sole proprietorship or LLC. What to choose?
Most business owners who are freelancers or consultants choose to start with a sole proprietorship. It is easy, the paperwork is minimal and tax filing is simpler. It also doesn’t really cost anything to file your business entity. Business owners also use this business structure to test their new business ideas and later changed to a different entity.
As your business grows, you find it hard to limit yourself in a sole proprietorship. You eventually need to step up the game. As you grow your personal assets are at risk and you can even go bankrupt if your business fails or meet any unexpected challenges. As an LLC owner, your personal assets will be safe and only your business is liable for your business debts and you’re more secure in case of lawsuits or bankruptcy.
You should understand what your business is about and consider various factors that affect your business like, costs, compliances, liability protection, taxes, etc. to decide whether you should go with LLC or sole proprietorship.
If you’re confused and can’t figure out what is best for you, We’re here for you! We will take a deep look into your business structure and help you choose the right entity for your business.