Pros and Cons of Sole Proprietorship vs LLC: Everything You Need to Know
There are many pros and cons of sole proprietorship vs. LLC. 3 min read
What Are the Pros and Cons of Sole Proprietorship vs. LLC?
There are many pros and cons of sole proprietorship vs. LLC. But before choosing which type of business to form, you should know what each one is.
An LLC, or limited liability company, operates as a hybrid of the partnership and corporate business structures, particularly due to the limited liability protection it offers and pass-through taxation benefits. The LLC is a separate and distinct entity from its owners. It can operate as either a manager-managed or member-managed LLC. This means the members (owners) of the LLC will manage the business. However, the members might choose to hire a manager to oversee the business operations.
A sole proprietorship is the simplest type of business to create. It involves only one member who creates the business and reports all profits and losses on his or her own personal income tax return. Generally, a sole proprietorship doesn’t have any employees. There isn’t any formal action needed to form your sole proprietorship. For example, someone who offers resume review services is considered a sole proprietor.
While there are advantages to both types of business structures, some businesses would be better off creating one type of business over the other, depending on the number of owners, objectives, and overall goals for the business.
Pros vs. Cons of the Sole Proprietorship and LLC
It’s important to understand the pros and cons of operating a sole proprietorship and LLC. Below are some factors to consider when determining which structure is better for your business.
- Complexityof forming your business
- Cost of forming your business
The sole proprietorship is the easiest type of business to form. There is far less paperwork when forming it. You really only need to begin doing business and ensure that you have obtained any applicable licenses and permits beforehand.
However, the LLC must take some additional steps before transacting business. Some of these steps include choosing a name for your business, hiring a registered agent, filing the Articles of Organization (and paying a filing fee), drafting an Operating Agreement, obtaining an EIN, and obtaining insurance.
Other than the fees required for obtaining licensing and permits, the sole proprietorship is nearly free to form since no other costs are required. This type of business structure doesn’t have any formal ongoing requirements, not even so much as a written agreement.
However, with that said, every business needs money to begin doing business. In a sole proprietorship, you will need to fund your own business by obtaining loans or using your own assets. And obtaining a loan for a sole proprietorship could prove challenging, as a lot of financial institutions are hesitant to provide a loan to a sole proprietor as opposed to an LLC, partnership, or corporation. Often, sole proprietors have to personally guarantee a loan given to the business, which could, in turn, cause personal liability if the business is sued.
An LLC has additional ways to raise capital, including adding new members who can bring their own capital contributions and creating new classes of membership interests.
A sole proprietor is taxed on all business profits. Therefore, the profits flow through to the owner. However, a single-member LLC might also be taxed in this manner since such businesses are considered disregarded entities by the IRS. Therefore, if the single-member LLC doesn’t elect taxation as a corporation, it will then be treated as a sole proprietorship. While such taxes are passed onto the owners of sole proprietorships and single-member LLCs, those owners can take advantage of the tax deductions for the business.
Furthermore, both business structures can potentially qualify for the pass-through deduction of up to 20 percent of all business income. This is a new deduction that took effect in 2018 under the Tax Cuts and Jobs Act.
If you operate as a sole proprietorship, you will be taxed as a self-employed individual. This means the income from your business is considered personal income. An LLC, however, can be taxed as a sole proprietorship, partnership, or corporation. But the LLC will need to make the election. As previously noted, if the election isn’t made, you risk being treated as a sole proprietorship (single-member LLC) or partnership (multi-member LLCs).
If you need help determining whether you should form a sole proprietorship or LLC, you can post your legal need 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, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.