Do you want to start a business as a Sole Proprietorship, or would you like to go for a Limited Liability Company with your partners?
When you have two different options, and both of them are good enough, then there is a chance that you might get confused between both of them.
And, in this situation, you might have found yourself in a dilemma whether the Sole Proprietorship will be a better choice for you or LLC will be the perfect one.
What are the pros and cons of a sole proprietorship and LLC business entity?
This article will discuss what a Sole Proprietorship is, its advantages, disadvantages, and what an LLC is, and the pros and cons of going for it.
Remember you should consider the legal, financial, and tax-related implications when you choose a business structure.
So, I encourage you to get guidance from an attorney and a tax or accounting professional as you decide.
What is a Sole Proprietorship?
When an individual starts a business with his funds and operates and manages every activity and function of the business independently, it is called a Sole Proprietorship.
Handling and Controlling a Sole Proprietorship requires no paperwork with the state for the formation process.
In a sole proprietorship form of business, the proprietor and the business are considered the same in law and legal and tax-paying.
Advantages of a Sole Proprietorship
When you form a sole proprietorship, you enjoy the below-mentioned benefits:
- There is no requirement for filing any paperwork with the state.
- There is no requirement of annual state filings in case of a Sole Proprietorship.
- All profits/losses are entitled to the owner’s account, and he is only liable for paying every individual state, local, and Federal Insurance Contribution Act (FICA) taxes.
- A Sole Proprietorship is not required to pay any unemployment or specific business tax.
- A Sole Business Owner can enjoy the same tax benefits of being self-employed by turning some of his expenses into business expenses.
Also, utilizing self-employed retirement plans for higher deductions, writing off business travel costs, writing off regular business expenses, writing off costs to entertain clients, and more.
Disadvantages of a Sole Proprietorship
Although, for a Sole Proprietor, there is some disadvantage:
- There’s no liability protection against commercial debts, court cases, and other obligations, which means that he can be sued personally for commercial activities, and all his assets can be at risk.
- It’s hard to generate Equity finance when it comes to a Sole Proprietor as many investors don’t want to put their funds in this kind of business entity.
And this is the primary reason that limits the business from growing, developing, and staying in the market.
It is hard to establish business credibility to acquire debt financing for a Sole Owner. Many Financing institutions will request your Business Loan request as a Personal Loan, making it a more challenging task.
What is an LLC?
A Limited Liability Company is a business category type under the state laws. It requires a State to construct formal registration.
Talking about the comparable business entity with a sole proprietorship, Single Member LLC always comes on the top. It has one owner called a member.
And when an LLC has more than one member, it is known as a Multi Member LLC.
An LLC is an entity with its Member/Owner and also the same tax-paying entity.
Advantages of Forming an LLC
When you form an LLC, your assets remain separated from creditor’s lawsuits and the business. With the LLC, Members can avail of the following benefits:
- Good market credibility.
- You can get liability protection against lawsuits, commercial debts, and other obligations. It means venue manager LLC without bringing in any personal or commercial assets in the business.
It also keeps your funding in the right way, then the liability protection will stay in its place, and nobody can sue you personally for your commercial activities.
- It’s easier to generate equity financing because of a separate business entity and a well-established business credit score.
It will help you avoid many equity partners and financial institutions who categorize your finance request as a personal loan than a business one.
It also brings in a variety of commercial debt financing options such as business credit cards, leases, small business loans, factoring and trade credits, and so on.
LLCs also enjoy all tax benefits of being self-employed.
Disadvantages of Forming an LLC
Following are the disadvantages of having an LLC:
- The requirement of State-related paperwork will be there with specific industry licensing.
- There will be a compulsory requirement of Annual state filings and the associated fees.
- Costs for filing the tax return of an LLC are comparatively higher than a sole proprietorship.
- Besides paying State, Personal, Federal, local, and FICA taxes, LLCs must pay Unemployment and State Business Taxes.
Sole Proprietorship Vs. LLC- Key Differences
Forming a Sole Proprietorship vs. LLC
Forming a Sole Proprietorship is quite simple. It all depends on the business kind that you want to do.
If there are some requirements to complete like obtaining licensing, zoning clearances, getting permits, and other permissions on a local government, then you have to get it to legalize your business.
On the other side, forming an LLC is a bit longer than a sole proprietorship, but it is relatively simple.
Firstly you need to give it a name and cross-check with the state whether that name is available before filing your documents with them.
For fulfilling legal and tax compliances, you will need a best registered agent.
Always remember that the IRS takes single-member LLCs as sole proprietors when it is all about taxation.
After that, you will have to file a certificate of formation, draft an Operating Agreement, and pay the filing fee.
In some states, you are supposed to obtain your EIN for taxes.
Funding a Sole Proprietorship Vs. LLC
No matter which kind of business entity you are talking about, funds will always remain on top and the most challenging factor.
Some of the sole proprietors keep on doing their full-time job before starting their own business as their income is the main and the first source of funds that they have.
And if you register your business as a separate entity, you need to open up a business bank account for doing business transactions.
The significant advantage you receive by legalizing your business and separating it from yourself and your personal and business income is that you will always have legal protection and your assets are safe.
Nobody can put away your assets for recovering their debt.
Another great thing is that when your business is a separate entity, money loan providers and financial institutions will lend you loans. You can easily do business transactions with your business bank account.
Now let’s talk about the funding of LLC. It seems a bit challenging to get a loan for your new business.
However, there are still many funding opportunities available in the market, like crowdfunding, which is trending rapidly.
Many non-profit lenders are offering microloans to support the new businesses. They have a bit different structure than standard financing, so make sure before taking any step forward.
Taxes for a Sole Proprietorship vs. LLC
The foremost and essential thing you have to do when you start a business is separate your personal and business finances and keep your documents in order.
It includes personal tax returns, income tax documentation, and any other documents related to any debts that you carry.
As a sole proprietor, you can qualify for filing pass-through taxation, and when it comes to paying self-employment tax, it will keep you safe a bit.
The tax rate you have to pay will entirely depend on your business type, so try to keep a proper NAICS code to avoid any unfavorable situation.
Filing taxes is quite simple for a sole proprietor. All you have to do is keep your business as a separate legal entity and keep all the finances and documents separate like receipts, 1099s, mileage, annual fees, etc.
You also have to keep a constant track of the influence outflow of cash on taxation. All the Sole proprietors are liable for paying the taxes on their own.
And you remember that one member LLC is considered sole proprietor when it comes to tax, but when members are too many, some kinds of income-qualified for the Federal tax rates mean that you can pay less than sole proprietor if you filed.
It will be handier if you keep your documents well arranged and updated regarding your payroll taxes, profits and losses, and any other paperwork related to real estate in the entity’s name.
In an LLC, a business will not pay taxes itself, and you can calculate based on profits and losses listed on your tax return, but if you have a proper division of funds, it will save you a decent amount in the long run.
Personal Liability For a Sole Proprietorship vs. LLC
When you have a new business, then legal protection is a must thing that you have to get for your business’s well-being and long-term running.
For safeguarding your LLC and yourself from any business liability, all you have to do is file with the state government keeping in mind the nature of your business and how risky it is.
An LLC is all about limiting your liability up to the business only. But it is a different concept in the case of a sole proprietorship.
As in sole proprietorship, the sole proprietor or the business owner is personally responsible for every step taken, every decision made and every risk incurred in his business.
The intensity of the risk will always depend on the business owner’s action; sometimes, it will be high, and sometimes low.
But a sole proprietor can also keep his business safe by doing insurance for additional protection for your business.
Managing and Operating a Sole Proprietorship vs. LLC
Running a business as a sole proprietor works in both ways. When talking about simplicity, all you have to do is get your job done, keep track of your income, and keep investing in the business and take it to the next level.
And coming to the complexity, it is hard to keep your business and yourself separated in a sole proprietorship. You are the only person who has the sole authority to make decisions, controlling actions at every step.
You are the only one who will correct all the mistakes that can happen while doing the business activities.
And if you want to work with someone, bringing their skills, productivity, and intelligence in, making them part of the decision-making process, and dividing the profits among yourself, LLC is a great option.
Here the jobs are pre-determined, and every person performs their assigned jobs.
Business Requirements For Sole Proprietors and LLCs
Some obligations are universally crucial for both sole proprietorship and LLCs. It includes:
- Pay income taxes (local income tax, federal, state, sales tax, payroll taxes.
- Obtain an EIN from the IRS to open a business bank account, hire employees, file taxes, and submit business documents with the State Government.
- Comply with the local zoning requirements.
- Obtain and renew applicable business licenses and permits.
The Closing Words
How you form your business is essential.
How you run it is also essential.
And how you take care of it for a long time is also again important.
So when the responsibility is all on your head, then everything is so necessary.
Talking about sole proprietorship offers you the freedom of making decisions at any given point in time without looking for anybody’s opinion and contribution.
Also, you have complete autonomy, and you get to enjoy all the prophets on your own.
LLC offers some protection and a variety of benefits that are worth your investment.
So this is it for this blog, and I hope you have got ample information about sole proprietorship and LLC.
Now it’s your turn to do your homework and launch your business and grab success.