Key Takeaways

  • The main difference between an LLC and a sole proprietorship is liability protection—LLC owners are protected from personal liability, while sole proprietors are not.
  • Tax flexibility favors LLCs, which can choose to be taxed as a sole proprietor, partnership, S corp, or C corp.
  • Sole proprietorships are simpler and cheaper to start but offer no legal separation between the owner and the business.
  • LLCs require more paperwork and annual fees but provide limited liability and more credibility when attracting clients and investors.
  • Business owners often choose an LLC for growth and protection, while freelancers or low-risk professionals may stick with a sole proprietorship for ease.

What is an LLC?

An LLC or limited liability company allows sole proprietors or partnerships to enjoy the benefits of pass-through income while limiting their liability. The liability of the owners is limited to the amount of their investment.

What is a Sole Proprietorship?

When one person runs a business, it is typically known as a sole proprietorship or simply proprietorship. There is no clear line between the owner of the company's personal assets and the assets of the business. Some sole proprietors use a "DBA" (Doing Business As) designation while others make no formal declaration.

LLC vs Sole Proprietor: Pros and Cons

Whenever a person is forming a business it is important to weigh the pros and cons of each business structure. Depending on the product or services you are offering, you may need more personal protection. Here are some of the pros and cons of LLCs and sole proprietorships:

Corporate Entity Pros Cons
Limited Liability Corporation (LLC)
  • Unless there are specific reasons, owner's assets are protected from creditors
  • Easier to raise money for funding company
  • Easier to sell/transfer business
  • Formation paperwork is required
  • Costly legal fees involved
  • Funds may not be comingled with personal funds or liability increases
Sole Proprietorship
  • Ease of setup
  • Lower costs/fees
  • Does not require formal paperwork to form
  • No concerns about comingling personal funds
  • Each owner can lose personal assets to creditors
  • To transfer to a new owner, assets must be transferred individually
  • Sometimes makes raising money difficult

LLC vs Sole Proprietorship: Key Legal and Operational Differences

When comparing LLC vs sole proprietorship, the most significant distinction lies in legal separation and personal liability. A sole proprietorship is not a separate legal entity—the owner and the business are legally the same. This means that if the business incurs debt or faces a lawsuit, the owner’s personal assets (such as their home, savings, or car) may be at risk.

An LLC, on the other hand, is a distinct legal entity created under state law. It separates the business from the individual, offering limited liability protection. This protection generally shields owners’ personal assets from business debts or legal judgments.

Operationally, LLCs also offer more credibility with lenders and clients. Many banks and investors prefer dealing with LLCs because they demonstrate a more formalized structure. Sole proprietorships, while easy to start and manage, often lack the perception of stability that comes with an established entity.

Tax Liability of a Sole Proprietor vs. an LLC

Because a sole proprietorship is only one person, and is unincorporated, it is not treated as a separate business. Therefore, the income and expenses are passed through to the owner and included on their personal income taxes. Schedule C or C-EZ is used along with Form 1040 for claiming income and expenses and self-employment tax is due on the net income of the business.

Recordkeeping, Reporting, and Compliance Differences

Recordkeeping requirements also differ significantly between an LLC and a sole proprietorship. Sole proprietors are not required to maintain separate business records—income and expenses are simply reported on Schedule C of the owner’s Form 1040.

In contrast, LLCs must maintain formal records, including separate business bank accounts, operating agreements, and annual reports in many states. Some states, such as California and New York, also require annual franchise taxes or filing fees to maintain good standing. These compliance steps ensure that the LLC maintains its limited liability protection and does not risk being “pierced” in a lawsuit due to commingled funds or poor recordkeeping.

Even though the administrative burden is greater, these steps protect both the owner and the business by preserving the LLC’s legal distinction.

LLC Taxes

LLCs can have features of both a corporation and a partnership. When there is only one person involved in an LLC it may be classified as either a corporation or a disregarded entity for tax purposes. Should an LLC elect to treat their taxes as self-employment taxes, they may lose any protection from personal financial liability.

If the owner of an LLC uses a C-Corporation designation, they should file Form 1120 and if they use an S-Corporation they should use Schedule K1.

Choosing Between an LLC and a Sole Proprietorship

Choosing between an LLC and a sole proprietorship depends on your business goals, risk tolerance, and long-term plans. If your business involves physical products, employees, or higher liability risk, an LLC offers critical legal protection. It also gives flexibility to add partners, investors, or transition to an S corporation later for tax savings.

A sole proprietorship may be a better choice for freelancers, consultants, or very small businesses with minimal risk and low overhead. It’s the simplest and least expensive option, making it ideal for testing business ideas without formal structure.

Entrepreneurs should also consider future scalability. Converting from a sole proprietorship to an LLC later is possible, but it may require filing new tax IDs, updating contracts, and paying additional state fees.

If you’re uncertain which entity best suits your situation, you can find an experienced business attorney on UpCounsel to help you assess your liability risks, tax strategy, and growth plans.

Partnership LLC

A Partnership LLC is created when two or more individuals decide to operate a business together and choose to formalize their arrangement through the formation of a limited liability company (LLC). Unlike an informal partnership, a Partnership LLC provides its members with limited liability protection, meaning each partner’s personal assets are generally protected from the business’s debts and lawsuits. To establish this structure, the partners must file Articles of Organization (or a similar formation document) with the Secretary of State and create an operating agreement outlining how profits, losses, and responsibilities will be shared among members. This type of structure combines the flexibility of a partnership with the liability protection of a corporation.

Single-Member LLC

A Single-Member LLC is a limited liability company with only one owner. It allows a sole proprietor to conduct business under an LLC while enjoying the benefit of limited liability protection. This means that even though there is just one owner, the LLC is legally distinct from its owner, shielding personal assets from business debts and obligations. The owner still enjoys the simplicity of pass-through taxation, reporting profits and losses on their personal tax return, but gains the added credibility and legal separation that comes with forming an LLC.

Single-Member LLC vs. Sole Proprietorship

While both a single-member LLC and a sole proprietorship can have just one owner, they differ significantly in liability protection and formality. A sole proprietorship requires no formal registration with the state—the business and the owner are legally the same. This simplicity makes it easy to start, but it also exposes the owner’s personal assets to risk if the business incurs debt or faces a lawsuit. In contrast, a single-member LLC creates a separate legal entity, protecting the owner’s personal assets from business liabilities.

Because the right structure depends on your goals, risk tolerance, and state regulations, it’s often wise to consult a business attorney before deciding whether to operate as a sole proprietorship or form a single-member LLC. An attorney can help you evaluate your options and ensure compliance with state filing requirements.

Frequently Asked Questions

1. Is it better to start with an LLC or a sole proprietorship? It depends on your business’s size and risk. Sole proprietorships are simpler and cheaper, but LLCs provide liability protection and credibility as your business grows.

2. Can I change from a sole proprietorship to an LLC later? Yes, many business owners start as sole proprietors and later form an LLC. You’ll need to register with your state, get a new EIN, and update licenses and contracts.

3. Do LLCs pay more taxes than sole proprietorships? Not necessarily. LLCs can elect their tax treatment, and depending on structure and income, they may actually lower tax liability compared to a sole proprietorship.

4. What are the startup costs for each? Starting a sole proprietorship costs little to nothing, while LLC formation fees vary by state—typically ranging from $50 to $500 plus annual fees in some states.

5. Which is better for getting business loans or investors? LLCs usually have an advantage, as lenders and investors prefer dealing with registered entities that provide structure, ownership documentation, and limited liability protection.

If you’re uncertain which entity best suits your situation, you can find an experienced business attorney on UpCounsel to help you assess your liability risks, tax strategy, and growth plans, you can post your question or concern on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience. They have worked with or on behalf of companies such as Google, Menlo Ventures, and Airbnb.