Key Takeaways

  • A sole proprietorship and an LLC are distinct business structures; an LLC cannot legally operate as a sole proprietorship.
  • A single-member LLC can elect to be taxed like a sole proprietorship but still retains LLC liability protection.
  • Sole proprietorships are simpler and cheaper to start but offer no personal liability protection, unlike LLCs.
  • LLCs require state registration, ongoing compliance, and separate business finances.
  • Choosing between the two depends on your risk tolerance, tax preferences, and business growth plans.

Sole Proprietorship LLC

While a sole proprietorship LLC is possible, it is important to know that an LLC (Limited Liability Company) cannot operate as a sole proprietorship. Therefore, an individual can, in fact, do business as an LLC. Every state has its own rules and regulations concerning the formation of LLCs within that particular state.

If you are interested in operating as a single owner of an LLC, you can hire employees or independent contractors to help run your business. But keep in mind that you will be the sole owner of the business, and therefore, you will be the one responsible for the oversight and daily operations of the business. With that being said, the LLC will provide you with limited liability over the debts and obligations of your LLC, which means that you cannot be held personally liable.

Advantages and Disadvantages of a Single-Member LLC

A single-member LLC combines aspects of sole proprietorships and corporations. The main advantage is limited liability protection—your personal assets are generally shielded from business debts and legal claims. You also have flexibility in how your business is taxed, choosing between sole proprietorship, S corporation, or C corporation taxation. Additionally, LLCs often enhance credibility with customers, vendors, and potential lenders.

However, a single-member LLC involves higher startup and maintenance costs compared to a sole proprietorship. You must file formation documents with your state, pay filing and annual fees, and maintain proper records. Some states also impose franchise taxes or annual report requirements. In addition, while liability protection exists, it can be lost if you fail to maintain a clear separation between business and personal finances.

Federal Tax

Since the Internal Revenue Service (IRS) doesn’t recognize LLCs as business entities, owners of the LLCs must choose how they wish to be taxed. For example, a single-member LLC can be taxed either as a sole proprietorship or as a corporation. If you wish to be taxed as a sole proprietor, then the IRS recommends that you report the LLC income on Schedule C of Form 1040 (personal tax return).

You might also be required to pay self-employment tax since you are reporting the income on your personal tax return. While you might view this as a tax implication, the one benefit here would be that sole proprietors need not file corporate income tax. Therefore, you are not subject to double taxation.

Even if you choose to be taxed in one of the above ways, this doesn’t mean that your LLC converts to that type of business structure. It simply means that you are taxed in that manner. You will still operate your business as an LLC, and your company will still enjoy the many benefits that an LLC has to offer.

Tax Flexibility and Self-Employment Considerations

A single-member LLC’s default IRS tax classification is “disregarded entity,” meaning it is taxed like a sole proprietorship unless you elect otherwise. This pass-through taxation avoids corporate-level taxes, with profits and losses reported on your personal tax return.

If you choose sole proprietorship taxation, you will pay self-employment taxes on net earnings, which cover Social Security and Medicare contributions. You may deduct certain business expenses to reduce taxable income. Alternatively, electing S corporation taxation can potentially reduce self-employment tax liability by splitting income between salary and dividends, but it requires adherence to payroll rules and IRS guidelines.

Even if you are taxed like a sole proprietor, your LLC remains a separate legal entity, preserving liability protection. It’s important to keep accurate records and consider consulting a tax professional to select the most beneficial tax status.

LLC vs. Sole Proprietorship

If you don’t know whether to operate as an LLC or sole proprietorship, you’ll want to do some research to learn the advantages and disadvantages of each type of business structure. Most importantly, an LLC offers limited liability whereas, a sole proprietorship does not. However, sole proprietorships are often less costly to form and operate as LLCs.

Additional requirements for the LLC include the following:

• You must register with the state and pay the initial registration and filing fees.

• LLCs pay yearly fees to maintain LLC registration status.

• LLCs are also subject to state laws that provide rules and regulations regarding LLCs.

• LLCs must keep business records and funds separate from personal records and bank accounts.

If you choose to operate as a sole proprietorship, you’ll be required to pay self-employment tax. However, if you choose to operate as an LLC, you can choose to be taxed as a sole proprietorship, partnership, or as a corporation. Keep in mind that if you fail to elect what type of business structure you’ll want to be taxed as, your business will automatically be taxed as either a sole proprietorship or partnership, dependent on the number of members (owners) in the LLC.

A disadvantage to operating a sole proprietorship is the fact that you will be held personally liable for any debts or obligations that your business incurs. Therefore, if a lawsuit is filed against your business, you can and will be held liable for any money owed to the plaintiff(s)in the suit. 

What’s more, a plaintiff can also name you as a defendant in the suit, which generally happens. Since you are not protected from liability, you risk losing all of your assets, including your money, home, car, etc. If you cannot shelter your business by insurance, then a sole proprietorship likely wouldn’t be the best choice for you.

Setting aside the liability issue, sole proprietorships are much more straightforward and cheaper to form and maintain. As long as you obtained the required licenses and permits, you can start your business. With an LLC, however, you must file an Articles of Organization and pay a filing fee, which could amount to a couple hundred dollars in some states.

Key Factors to Consider When Choosing

When deciding between a sole proprietorship and a single-member LLC, consider these factors:

  • Liability Protection: Sole proprietorships offer no legal separation between you and your business. LLCs shield personal assets in most cases.
  • Startup Costs: Sole proprietorships have minimal or no formation fees, while LLCs require state filing fees, which vary widely.
  • Administrative Requirements: Sole proprietorships are easy to maintain, while LLCs must comply with state reporting, renewal fees, and recordkeeping rules.
  • Tax Options: Sole proprietorships have one tax treatment; LLCs can choose from multiple tax classifications.
  • Business Credibility: LLCs may instill greater trust with clients, suppliers, and investors.
  • Scalability: An LLC makes it easier to add partners or convert to a multi-member entity without changing the legal structure.

If liability exposure is minimal and simplicity is a priority, a sole proprietorship may suffice. If you want personal asset protection and flexibility for growth, an LLC may be the better choice.

Frequently Asked Questions

  1. Is a sole proprietorship the same as an LLC?
    No. They are distinct legal structures. An LLC provides liability protection and more tax options, while a sole proprietorship is simpler but offers no liability shield.
  2. Can a sole proprietor form an LLC?
    Yes. A sole proprietor can register an LLC with their state to gain liability protection and access to other LLC benefits.
  3. Can an LLC be taxed like a sole proprietorship?
    Yes. A single-member LLC is by default taxed like a sole proprietorship unless you elect S or C corporation status.
  4. Which is cheaper to start—an LLC or sole proprietorship?
    Generally, a sole proprietorship is cheaper to start and maintain. LLCs require filing fees, annual fees, and more administrative upkeep.
  5. Do both LLCs and sole proprietorships pay self-employment taxes?
    Yes, if taxed as a sole proprietorship or partnership, both pay self-employment taxes. Electing S corporation status may reduce this obligation.

If you need help forming a sole proprietorship or an LLC, or if you need assistance determining which type of business structure is right for you, 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.