Sole Proprietorship vs LLC vs Corporation: Everything to Know
Picking between a sole proprietorship vs. LLC vs. corporation is an important decision that every business owner makes.3 min read
Picking between a sole proprietorship vs. LLC vs. corporation is an important decision that every business owner makes. Each structure has its benefits, which means choosing the option that fits your business requires a good amount of research.
When you're planning a new business, you must do some careful planning, including picking the type of entity that fits your needs. For small business owners who aren't interested in establishing a partnership, three entities are available:
- Limited liability companies (LLC).
- Sole proprietorships.
As each entity has its pros and cons, the option you choose will largely depend on the goals of your business. With a sole proprietorship, you will essentially be operating your business as yourself. Sole proprietorships do not require formal structuring, making them very easy to start-up.
When it comes time to pay taxes, the income of a sole proprietorship passes to the owner and shows on their personal return. This reporting format is beneficial because it means sole proprietorships are not subject to double taxation. However, in addition to income, business liabilities are also passed to the owner.
By running your business as a sole proprietorship, you're not protected from the debts of your business. If someone gets injured at your business and wins a lawsuit judgment, they can pursue your personal assets. Another disadvantage is that you cannot sell your sole proprietorship whole. All of the assets of your business, including your permits and licenses, are individually sold.
With a sole proprietorship, you would need to acquire a new bank account and tax ID number. Outside of obtaining the permits and licenses required by your state, you will not need to take any formal action to establish your sole proprietorship. You will need to visit your county clerk to establish a Doing Business As (DBA) if you want to start a sole proprietorship. This DBA prevents other people in your county from doing business under your name and also allows you to obtain credit cards and bank accounts for your business.
Limited Liability Company
Many business owners choose to form an LLC to provide themselves with advanced liability protections. LLCs can either be used to operate a business or to hold certain assets such as real estate. LLC owners are referred to as members, and these companies can have unlimited members or be owned by a single person. In some cases, the members of an LLC will manage the company themselves. In other cases, the company will hire outside management.
LLCs protect members, directors, and officers for the liabilities of the company, even if they were negligent in running the business. A variety of circumstances exist where these personal liability protections do not apply:
- A debt has been personally guaranteed by a member.
- The funds of the LLC and personal funds become mixed
- The insurance or capital of the LLC has a limit.
- The LLC has violated state law or has not paid its taxes.
One of the main reasons to structure as an LLC is having limited liability and the tax benefits of partnerships. When you set up your LLC correctly, the income earned by the company passes to members and the members pay taxes at their individual rates.
Corporations are businesses that a group of shareholders owns. These shareholders will appoint a board of directors to manage the company. In some cases, a board of directors may only have one person. Instead of handling day-to-day operations themselves, directors of the company will hire officers to handle these duties. Shareholders of a corporation, as well as officers and directors, have protections from the liabilities of the company.
In standard corporations, known as C corporations, owners are not passed losses and profits. C corporations file their own returns and are responsible for their own taxes. At the federal level are no graduated brackets for corporate income tax. Some states require corporations to pay a franchise tax, which is essentially a state-level corporate income tax.
When a corporation wants more beneficial taxation, it can opt for S corporation status with the IRS. S corporation status allows the company to pass income and losses to shareholders, circumventing double taxation.
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