Sole Proprietorship vs. LLC: How to Choose

Susan GuilloryUpdated May 20, 2021

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When it comes to choosing a business structure, you may wonder whether you should form a limited liability company (LLC) or a sole proprietorship.As you consider the two business entities, realize that both an LLC and a sole proprietorship have their own particular benefits and drawbacks. Your specific business needs will determine which works best for your company.

Sole Proprietorship vs. LLC: the Two Biggest Differences

The most significant differences between a sole proprietorship and an LLC structure come down to the requirements to set up each kind of business and how your personal assets are treated in each structure.Basically, you don’t have to do anything to set your business up as a sole proprietorship. If you want to form an LLC, you must file paperwork, pay a fee, and wait for your state’s Secretary of State to approve your business as an LLC.As for your personal assets, with a sole proprietorship, they may be claimed to pay business debt. But if you have an LLC, you and the business are considered separate entities so your personal assets are separate. Now let’s dive into the details of each kind of business structure.

What Is a Sole Proprietorship?

Let’s start with the sole proprietorship. When you start a business, you can elect a specific business structure, meaning that you formally register it with your state's Secretary of State and pay a fee. If you don’t do that, your business is automatically considered a sole proprietorship (or a partnership if you have partners).In a sole proprietorship, you and the business are considered one entity. You file only your personal taxes, and you claim both business income and expenses on them.

Advantages of a Sole Proprietorship

When it comes to the benefits of a sole proprietorship vs an LLC, the biggest advantage is the ease of setting it up: It takes no effort at all. Your business is a sole proprietorship simply by default.Taxes are also simple, since you file only your personal income taxes and don’t have to file separately for the business.There are no fees required to be a sole proprietor..

Disadvantages of a Sole Proprietorship

There are, however, some drawbacks to sole proprietorship to consider. First, because there is no delineation between you and your business, your personal assets could potentially be seized should the business have debts or legal fees that it can’t cover. That could jeopardize not only your business, but also your personal life if, for example, your home or vehicle is taken to cover business debts.You may have difficulty if you try to get business financing through an investor or a bank when you are a sole proprietor. You could also struggle to sell your business if you haven’t elected a business structure like an LLC or corporation. Because the LLC is separate from its owner, it may be more appealing to lenders, investors, and potential buyers due to the limited risk.If you have a sole proprietorship but don’t want to do business under your own name, you’ll usually have to file your DBA (Doing Business As) name. Let’s say your name is Jane Doe but you want your company to be called Dr Knowhow’s Resume Writing Service. That’s fine, but it will generally require extra paperwork to file that DBA name.The filing fee can cost between $5 and $100, depending on your state.

What Is an LLC?

LLC stands for limited liability company. To use this business structure, you must elect and apply for it. If a company is an LLC, it’s separate from the business owner (or owners, if there are multiple owners), meaning that the owner or owners aren’t held personally responsible for the business’ liabilities.Let’s look at the pros and cons of LLCs.

Advantages of an LLC

When it comes to an LLC, unlike a sole proprietorship, your personal assets can’t be taken to cover business debts. You have, as the name indicates, limited liability.A sole proprietorship can happen more or less by default, so it’s not the best point of comparison for how much work it takes to elect an LLC. But in contrast to another business structure, the corporation, the LLC requires less paperwork to set up and maintain, since a corporation requires annual meetings and annual reports.LLCs can choose how they’re taxed. They can take advantage of what’s referred to as pass-through taxation, in which the business doesn’t file and pay its own taxes. Instead its income and expenses are passed through to the owners’ personal tax returns. This equates to the LLC being taxed like a sole proprietor, and may mean it can be referred to as a “disregarded entity”.Alternately, an LLC can also be taxed like a corporation at a lower corporate rate for the first $75,000.Another benefit is that an LLC has no limit on the number of members (or shareholders) it can have. An S corporation, by way of comparison, is limited to no more than 100 shareholders.You may find it easier to qualify for financing or to sell your business if it’s an LLC.

Disadvantages of an LLC

So what are the drawbacks? To start a limited liability company you have to apply with your state’s Secretary of State department, which may require a fee and take time for the paperwork to be processed. You may also have to pay an annual or biannual fee to keep your LLC in good standing. As of 2020, those fees (in states that require them) range from $9 in New York to $800 in California. Additionally, you may have to pay unemployment insurance for yourself and any partners, although you wouldn’t have to do so for a sole proprietorship. Costs for unemployment insurance vary by state.

How to File an LLC

Start by reviewing the requirements set out by your state’s Secretary of State. Each state has a slightly different process. Some let you apply online, while others may require you to mail in your application.You will likely be required to file articles of organization, which is a document outlining information about your business and its members. You may also be required to file other forms as well as pay a filing fee, which may range from $50 to $500. Some states may require you to have certain business licenses or permits to qualify as an LLC.Additionally, you may be required to file an annual report and pay an annual fee to keep your LLC in good standing.

Working With a Registered Agent

If you think the process of setting up an LLC yourself sounds overwhelming, you have another option. You can employ the services of a registered agent. This is an individual or company who can set up your business structure on your behalf, as well as ensure that you keep up with annual fees and paperwork deadlines. Registered agents charge a fee for their services.

How to Choose a Business Structure for Your Company

Still trying to decide between an LLC and a sole proprietorship? Consider how much effort you’re willing to put into setting up your business structure, and the fees you’re willing to pay. An LLC does require some effort to prepare, and it may require an annual fee and/or paperwork to be filed.You may also want to factor in how likely it is that your business might ever be sued. If you run a writing business out of your home, that risk might be minimal. But if you have a fitness training business, you might incur more risk of being sued, if, for example, a customer is injured while you’re training her.Finally, think about how likely you are to want to get investors or bank funding for your business someday. An LLC will likely be more appealing to potential investors or lenders than a sole proprietorship. And it may also be easier to sell an LLC.

The Takeaway

When you’re looking at a sole proprietorship vs. an LLC, the most important thing is that you carefully consider which will provide the biggest benefit to your business. How you file and pay taxes, whether you separate your personal assets from the business’s assets, and whether you’re willing to go through the process and paperwork of setting up and maintaining a legal business structure should weigh into your decision.Whatever you end up deciding, down the road you may find that your business could benefit from some funding. We can help. By filling out just one form, you can access our network of lenders and compare offers. That can save you time so you can focus on running your business.

This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice. The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC21039

About the Author

Susan Guillory

Susan Guillory is the president of Egg Marketing, a content marketing firm based in San Diego. She’s written several business books, and has been published on sites including Forbes, AllBusiness, and Cision. She enjoys writing about business and personal credit, financial strategies, loans, and credit cards. Follow her on Twitter @eggmarketing.

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