1. Startup Considerations
2. Tax and Finance
3. Reporting and Meeting Requirements
4. Growth and Other Considerations
5. Legal Risks of Website Ownership
6. Forming an LLC

Knowing the difference between sole proprietorship vs. LLC for online business is an important undertaking for those starting a new business online. This is because a sole proprietorship and limited liability company have different legal requirements and tax treatment. It's important to understand the differences between these entities to make the right choice for your new endeavor.

Startup Considerations

If simplicity is your goal, a sole proprietorship may be right for you. With this business entity, you do not need to register with the state and can file taxes using your Social Security number rather than a business identification number.

To start an LLC, you'll need to file Articles of Incorporation and an operating agreement with the state where your business will be located. The fee for LLC registration varies by state. In some cases, you may also need to obtain an employer identification number (EIN) from the IRS. The Secretary of State website can provide more information about specific requirements.

Both sole proprietorships and LLCs are required to get appropriate business licenses from their state and/or municipality.

Tax and Finance

Both single-member LLCs and sole proprietorships are considered pass-through entities for tax purposes. You will report business income and loss on your individual tax return and will not be subject to income tax at the corporate level.

These two structures are also treated in the same way by most banks, but it's important to review the requirements of the specific financial institution.

Reporting and Meeting Requirements

Neither sole proprietorships or LLCs have to hold board meetings, but they may be required to report monthly or quarterly sales depending on state law. Most states require LLCs to file an annual report with a fee.

Growth and Other Considerations

Other elements to consider when choosing the best entity for your online business include the following:

  • An LLC is often the best choice if you expect to grow your business, hire employees, and/or seek investors in the future. If you start with a sole proprietorship, you will need to convert to an LLC if you decide to take these steps in the future.
  • Forming an LLC may increase your credibility with customers, vendors, and lenders.
  • If your LLC is sued, your personal assets are not at risk. This is not the case if your sole proprietorship is sued. Business debts and liabilities are considered your personal debts and liabilities in a sole proprietorship. Although you may think your business will never be sued, someone could be injured on the premises or you could be accused of trademark infringement. Even if you are innocent, you will need to shoulder the cost of defense.
  • Registering an LLC prevents another entity from taking your business name. However, if you have a sole proprietorship, you can register a fictitious name ("doing business as," or DBA) to protect the name of the business.
  • LLCs must notify the state and distribute assets upon closing; sole proprietorships do not.
  • LLCs are required to appoint a Registered Agent who is responsible for accepting process service and other legal documents on behalf of the business.

You may think an online business carries less risk than a traditional store, but that's not necessarily the case. The fact is that your business can be sued at anytime for any reason. Potential issues to keep in mind include:

  • Libel, defamation, or slander accusations based on content published on your website.
  • Liability associated with affiliate offers.
  • Collection of personal information and relevant data-protection laws.
  • Use of copyrighted and/or licensed materials such as audio, video, and/or images.
  • Product and/or service liability.

Small business owners may opt to form an LLC to protect them from personal liability in case one of these common types of lawsuits arises.

Forming an LLC

To create an LLC, you'll need to first make sure that the name you plan to use is available in your state. You need to appoint a state resident or business to serve as your Registered Agent, or opt to fill this role yourself. You may also need to request a free EIN from the IRS to pay business taxes and open accounts.

If you need help with deciding between a sole proprietorship and an LLC for your online business, 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.