If you only knew how many enterprising and talented entrepreneurs are willing to risk their stability, give up their comfy work chairs and start a small business!

Oh, if only it were so simple! To succeed in a business project, you will have to solve more than a dozen issues. It concerns the choice of the company name, the implementation of advertising, financing, the need to involve third-party employees, etc.

However, before deciding on all these issues, you need to choose the type of enterprise that will correspond to your business area and guard your interests.

Most entrepreneurs who run a business alone choose to operate as sole proprietorships or create limited liability companies (LLCs) with one member. Choosing between these two types of entity units can be harder than it seems at first glance.

You should agree that solving such essential business problems requires professional assistance! So, we have prepared a guide for you with a detailed explanation of the differences between LLC and sole proprietor. Our goal is to help you understand which business method entity is right for you.

Do you already know that a limited liability company is right for you? – Fine! Explore the top LLC services and compare which ones save you time and offer the best conditions. Or use our free guide to create an LLC yourself.

Form Your Business Correctly 

So, let’s take a closer look at the available entity forms for implementing your business project at the legal level.

A Sole Proprietorship

Perhaps the most obvious solution for those who want to sell their goods and services is to start a sole proprietorship. This organizational business unit requires little effort to create. After completing the first transaction and earning income, you formally take the path of a sole proprietorship.

Of course, not all individual entrepreneurs have to follow the rules of the bureaucracy and submit many documents to various government agencies. However, all of them are required to obtain licenses and permits that regulate the activities of the enterprise in each specific industry. Let’s take a look at a particular example.

You are the most accomplished home pastry chef in your area and are a self-employed person. To work, you will need to obtain an appropriate license from your state or county.

Formally, the legal name of the proprietor is the name of a sole proprietorship. At the same time, many business owners prefer to register a DBA. This move largely contributes to business development and attracting potential customers.

A Limited Liability Company

Setting up an LLC will be a little more difficult. To get started, you will have to contact the office of the secretary of state. Of course, you will have to work hard, fill out a lot of paperwork and pay government fees. Note that each state sets its time frame for considering each specific appeal and charges commission fees individually.

And yet, many states are doing everything to simplify this task for future businessmen. So it is much easier to create an LLC than, for example, to acquire your corporation. As a rule, if the state accepted your appeal and did not return the package of documents you collected and the provided charter of the organization, this means that you can be congratulated! You have already become the owner of the LLC.

Of course, you will need to take care of appointing a registered agent. This staff unit will assist you in resolving issues related to legal procedures. You can perform these functions yourself. However, as the experience of other companies shows, it is better to use a professional service.

The next step will be the conclusion of an operating agreement by all members of the created limited liability company. Also, LLC owners should take care of obtaining licenses at all legal levels in the state. If you plan to attract employees, be sure to get the EIN in the IRS and register for the timely fulfillment of your tax obligations.

Business Project Management & Maintenance

A Sole Proprietorship

Managing and maintaining a sole proprietorship is easy enough. Maintenance of such a business unit does not require:

  • filing annual reports;
  • maintaining financial papers;
  • attracting third-party agencies for the narrowly focused provision of services.

However, some taxation issues require proprietor attention:

  • file Appendix C to Form 1040, which shows the profits and/or losses of your business;
  • complete Appendix SE to calculate your self-employment tax liability.

A sole proprietorship is not a separate legal entity from its owner. It means that you do not need to separate personal and commercial finances as is done for formal commercial structures.

And yet, there is an important issue that requires your close attention. It concerns licensing issues for your business. Each license has an expiration date, which you must monitor for yourself!

A Limited Liability Company

The requirements for managing an LLC are much larger and more complex than those related to the sole proprietorship. As with the sole proprietor, owners need to keep their licenses up to date. However, the personal assets of the owners and the company are separate.

LLC owners must complete and submit annual accounts. It is a kind of collection of informational data about the business you have done in the past financial year. In the LLC annual report, you need to enter the following information:

  • information about the hired registered agent;
  • information about all members who are in the owner group;
  • the exact address of the LLC registration.

Do not forget that you need to pay for the delivery of the annual accounts. Each state independently sets the amount of this fee (from $10 to $1,000).

Like any business, your LLC will grow and develop. For example, the composition of the owners may change, or you can assume responsibility for the management of the LLC. In any case, the charter requires amendments.

In addition, if the business methods change, then the operating agreement will require revisions. Remember that every change needs to be reflected in official papers!

Legal Framework for LLC & Sole Proprietorship

A Sole Proprietorship

Requirements for a sole proprietorship on the part of government agencies are minimal. Did you take care of paying taxes and obtaining/renewing the licenses and permits you need in time? – Fine! That’s all you need to do!

A Limited Liability Company

The list of legal requirements for an LLC is much broader than for a sole proprietorship. LLC owners need to keep strict records of:

  • income;
  • expenses;
  • assets;
  • shopping;
  • deductions.

In addition, LLC owners must also file annual reports, obtain licenses and keep them up to date, etc.

If you, as the owner of an LLC, employ a staff of hired employees, you must purchase policies of some type of insurance:

  • unemployment insurance (usually in the form of tax);
  • workers’ compensation in case of unforeseen / force majeure situations.

To comply with the state requirements, you need to know what laws you need to obey. Check with your state secretary’s office for accurate information.

Fundraising Aspects

A Sole Proprietorship

It will also be difficult for a sole proprietorship to raise funds. You will have to solve several tasks to attract third-party investors. The latter are very reluctant to cooperate with individual enterprises. In addition, you do not have the authority to issue stocks or bonds. And that largely ties your hands in fundraising.

The best solution to this issue would be to contact private lenders. However, remember that this business unit does not imply a separation of personal and business assets.

It means that creditors can seize your personal property in case of non-payment of debt obligations. Besides, keep in mind that your credit rating determines whether private banks will cooperate with you or not.

LLC

LLCs are formal commercial structures and have more fundraising opportunities. The owners of an LLC cannot put up shares for sale, but they can sell other types of securities. It applies to bonds and memberships.

Unfortunately, private investment companies are reluctant to invest in transactions with transit organizations, which are LLCs. Of course, they are much more willing to work with corporations. 

However, LLCs can apply for business loans. It is an indisputable advantage and many businessmen, for this very reason, prefer to register an LLC.

Issues Of Taxation

A Sole Proprietorship

Every sole proprietor is exempt from paying income tax. However, he will need to enter the relevant data on the personal tax return and indicate the corporate income tax. So, you are required to pay the personal income tax rate. It is worth noting that this rate is calculated following the size of your income and may be lower than the corporate income tax rate (21%).

However, you will have to pay 15.3% self-employment tax. It includes Medicare and Social Security shares. Detailed data on these types of taxation is available here. Usually, when you are involved in activities in a public or private enterprise as a hired employee, this tax is deducted from your salary. And if you are an employer for yourself, then you pay these taxes from your income.

LLC

LLC can enjoy flexible taxation terms. As taxation as an LLC, you can choose at your discretion how you will pay taxes:

  • as a sole proprietorship (LLC with one member);
  • full partnership (LLC with several members);
  • as a corporation.

In the first two cases, the procedure for paying taxes is identical to the process that the sole proprietor goes through.

If you choose the C corporation tax option, be prepared for double taxation. C corporations pay taxes at the corporate income tax rate and then use personal assets again when the company is forced to pay dividends.

This form of taxation entails stricter obligations than the default pass-through taxation. You can use this method if your partners are solvent. They should receive a high income and can save money by evading paying all taxes at individual rates.

Besides, LLC owners may prefer corporate taxation S. It is a form of pass-through tax, which in many ways resembles the default tax option. Note that the tax department qualifies LLC owners as S corp employees. It allows them to avoid paying self-employment taxes.

The S corp form has some restrictions:

  • each owner must be a US resident or citizen;
  • the company cannot have more than 100 owners;
  • commercial organizations may not have an ownership interest in the company.

It is these limits that make the S corp model less common.

Ensuring Liability Protection 

Liability protection issues are the most essential thing that distinguishes individual entrepreneurship from LLC. Many businesses perceive liability protection as the head motivation for registering a business unit.

A Sole Proprietorship

A sole proprietorship does not imply the separation of the owner’s business finance and the assets of the company itself. As a result, if your business is involved in a lawsuit or defaults on the loan, you will have to pay debts from your financial savings. It means that your assets (for example, a car, expensive equipment, housing, personal bank accounts, etc.) are at risk if someone decides to bring you to court.

LLC

Want to get personal asset protection? – Then you’d better organize an LLC. LLC is a legal entity! So, in the dispute with creditors, will pay debts from the company assets (under the law norms). Owners’ assets are beyond the reach of creditors. However, there are several exceptions. For example:

  • the LLC deliberately participated in fraudulent schemes;
  • it did not receive proper service. 

In those cases, the seizure may be imposed on the personal assets of the owners. It is a corporate veil, and you must be clear about this concept.

To implement this protection, separate the financial assets of the company and each of its owners. Failure to do so can destroy your corporate veil and that protection.

Company Name As An Opportunity To Promote Your Business

LLCs are lucky to get the opportunity to register their rights to the chosen company name. It can be a good marketing ploy, as your company will be recognizable in the market! And its name will belong only to it, and no other company can claim it.

Individual entrepreneurship does not have such an exclusive right. Of course, it often files a DBA, but some states allow several companies to have the same fictitious name. So you lose your individuality, and with it, potential customers. Want to get exclusive rights to your company name? – Then, choose the LLC entity unit!

Is liability security vital to your business?

Of course, it is! Obtaining personal liability protection is a smart decision. For this, it is most expedient to create an LLC. Make this decision following the scope of your business. Besides, take into account the types of goods and services that you are selling or intend to sell.

Let’s look at a specific example again. Remember we discussed the sale of private confectionery products? – So, just imagine that one of your customers was poisoned by your cake. Naturally, he will go to court! You will need to reimburse him for treatment, but your business funds may not be enough. If you are a self-employed person, the court will likely take your personal belongings to pay for the treatment of a disgruntled client. With LLC, such a problem would not have arisen!

However, some low-risk businesses may not need this protection. Take Etsy’s craft workshops, for example. Many of these artisans are self-employed. As there is little risk of injury from these products, the importance of liability protection is reduced.

LLC or a Sole Proprietorship: The Bottom Line

The choice between LLC and sole proprietorship is very difficult, and it requires reflection and weighing all aspects of your business project. If you are planning a large-scale business and high income, it is better to create an LLC.

After all, high profitability is always associated with high risks. In addition, LLCs offer more potential for growth, especially if you want to attract outside investors and employees to the business.

A sole proprietorship is perfect if:

  • you want to test your business idea;
  • do not want to spend money on LLC registration (such costs are too burdensome for a startup with low capital).

Start as a sole proprietorship and then transform your business into an LLC. It is not prohibited by law and does not cause any particular difficulties.

Get legal advice to help you weigh the pros and cons! Every business project is unique, so what works for one business may not work for another. A business attorney can help you select the type of business unit that will help you get your business to the top of the market.

Do you want to know our objective opinion? – Create an LLC! In almost all cases, it will bring more value to your business than a sole proprietorship. As a rule, each sole proprietor will have to deal with emerging difficulties on his own.

Services such as ZenBusiness and LegalZoom make it easy for you to set up an LLC. Highly qualified specialists will surely cope with the routine paperwork and interaction with government agencies and their departments.

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