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For an aspiring entrepreneur, it is one of the hardest decisions to make when choosing a business structure. Every business structure comes with its advantages and disadvantages. Perhaps this is why they find themselves in so much of a dilemma, especially when it is about sole proprietorship vs. LLC. Both of these business structures are suitable for small and medium-sized businesses.
As both these structures are similar, it is more difficult to choose one. On this page, LLCBuddy editors devise a detailed comparison between these two. Let’s dig more to get an idea of which one is suitable for you!
What is a Sole Proprietorship?
As the name implies, it can be understood that in a sole proprietorship, the owner will have unlimited control over every aspect of the venture, be it the finances, legal matters, taxation, and so on. This kind of business model is unincorporated, meaning the company and the owner won’t be separate identities. Rather, all the business requirements will be fulfilled under the name of the sole proprietor.
What is an LLC?
This form of business will offer you complete Limited Liability Protection, because of which most companies are established as a limited liability company only. Here, the business structure is formed in a way where the member/members can receive legal protection for their assets and interests if somehow the business faces issues like debts, lawsuits, and others.
LLC vs. Sole Proprietorship
LLCs and Sole Proprietorships are similar yet different from each other. In this section, editors shared a comparative guide on how LLC and Sole Proprietorship are similar or different.
Organization Structure
Sole Proprietorship: In a sole proprietorship business, there will be no partnership between the company members. Rather, there will be only one owner, who will represent the business in every way. Instead of being a separate entity, the organization and the individual owner will be amalgamated to form all the documentation in your name. The sole proprietorship business focuses on a handful of audiences, like the local market, families, and friends. Employees are hired only when the proprietor obtains the EIN number and establishes a bank account.
Limited Liability Company (LLC): Two major structural representations exist for these LLC companies: single-member Limited Liability Company and the multi-member Limited Liability Company. In the former structure, only one person holds the superior authority of the entire organization. However, if multiple partners form the company, the authority will rest in each partner’s hands, based on the percentage of ownership.
Management
Sole Proprietorship: The sole proprietorship business will be managed by the business owners only. These are small-scale businesses, with or without employees, so being a sole owner wouldn’t cause any trouble for you. Every decision will come from your side, and you wouldn’t have to worry about reaching common ground with other participants in the company.
LLC: The LLC business type can be operated in two different ways. If the company is being managed by one or more members, it comes to be known as a member-managed LLC. However, there is a possibility that the members assign a third-party manager to oversee the entire company’s functionalities. Under such a scenario, the company is said to be a manager-managed LLC.
Finances and Taxation
Sole Proprietorship: The business income from a sole proprietorship will be based on the total profits earned by the company in a given financial year. Being the only owner, you will earn the entire profits, and it will not be divided into shares for multiple members. As for the taxes, you need to pay the amount from your business earnings, including the self-employment taxes and the individual tax return. There will be no pass-through taxation benefit for the sole proprietorship business.
Limited Liability Company (LLC): Whatever money you earn as a single-member LLC, it will be your profit, and you will be liable to pay the income and sales taxes based on the business structure mentioned at the IRS. However, if you are involved in a multi-member LLC, you will have the profit based on the ownership percentage, and only then will you file the taxes. Hence, such LLCs are said to be pass-through entities. Apart from these taxes, you also need to worry about the pension tax and the payroll taxes.
Asset Protection and Liability
Sole Proprietorship: With this particular business structure, you wouldn’t get the liability protections. Even if the business incurs losses or goes bankrupt due to multiple debts, you will have to handle the responsibility of these issues. Here, your personal liability wouldn’t remain separate from the business assets.
Limited Liability Company (LLC): With an LLC, you can take help from popular asset protection consultants like FreshBooks to learn how the LLC will protect your assets from business issues. With the LLC, you will not have your personal assets at risk from the business liabilities.
Sole Proprietorship: Pros and Cons
While there are significant upsides to setting up a sole proprietorship, there are downsides as well. Here are the pros and cons of a sole proprietorship.
Pros
- Allows you to have full control: One of the main reasons for forming a sole proprietorship business is the opportunity to have complete control over this type of business. As you will be the sole owner, you won’t have to answer to anyone or provide an explanation against a reform or a decision.
- No legal complications during the formation: You won’t have to worry about facing tons of legal complications when you are forming the business structure. Since it is an unincorporated organization, you can form the company without showing any important documents.
- Needs little to average capital investment: You won’t have to worry about the initial investment because, in the sole proprietorship business, the business’s finances are very minimal, and hence, you won’t have to increase the capital too much.
- Decision-making time is very low: You can handle the business affairs without anyone’s intervention. There will be no need to sit in meetings with others for hours to improve the company.
- It can be operated without conflicts of interest: Finally, there’s no need to worry about the differences between the interests of the participating members. Since it is a single-operated company, you will be able to pay attention to your thoughts.
Cons
- No protection will be provided to the personal assets in the sole proprietorship companies, so you will have to bear the business expenses on your own.
- You must pay all the business debts and loan amounts until the credit is cleared. If not, then the company might go into bankruptcy, causing losses in your personal assets, too.
- The individual income tax and the self-employment taxes need to be paid from your own profits, which further reduces the overall earnings.
LLC: Pros and Cons
The pros of limited liability companies are quite evident, but it is still worthwhile to check the cons. Here are the advantages and disadvantages of forming an LLC.
Pros
- Reduced risks to personal assets: With the LLC, you will be able to enjoy the personal liability protection benefits since your assets will be protected. No matter whether the business is facing huge credit debts or on the verge of being dissolved, no harm will come to your assets, which is why this separate business entity is perfect for many entrepreneurs.
- Multiple tax benefits: One of the major reasons for having an LLC company is the tax benefits such a structure offers. Here, you can enjoy the pass-through taxes, where you will have to file the report only when you receive the profits as per the percentage of ownership.
- Flexibility in management: LLC can be operated by you or by a manager appointed by the company’s members. This has introduced a lot of flexibility in the LLC businesses, which is why it’s far better than the sole proprietorship.
Cons
- One of the major disadvantages of the LLC is the payment of self-employment taxes to the state government, both for domestic and foreign LLCs.
- If the budget is not formed correctly, LLCs can be difficult to operate.
F.A.Qs
No, the taxation levied on the sole proprietorship company s far different from the LLC since both these companies are formed on different grounds. For example, as a sole proprietor, you need to pay the taxes from the profits. But, as an LLC member, you don’t have to spend your profits to pay the taxes.
Obviously, the sole proprietorship company will always be at higher risks as compared to the LLCs. Hence, you need to be very certain about the type of business you want to establish. If you are confused, you can take help from professional consultants like FreshBooks.
Which is Better LLC or Sole Proprietorship?
LLC is preferred over sole proprietorship because it protects your personal assets in case your business suffers any kind of loss or gets sued.
A sole proprietorship is the simplest form of business structure, where the business is owned and operated by one individual. This means that the owner is personally responsible for all aspects of the business, including any debts or legal liabilities that may arise. While this offers a great deal of autonomy and control, it also means that the owner is personally exposed to risks and potential liabilities. Additionally, obtaining financing or attracting investors can be more challenging for sole proprietorships due to the lack of perceived stability and structure.
On the other hand, forming an LLC provides business owners with the benefits of limited liability protection. This means that the personal assets of the owners are generally protected from the debts and obligations of the business. Additionally, LLCs allow for more flexible management structures and the ability to pass through profits and losses directly to the owners for tax purposes. However, forming an LLC involves additional paperwork and administrative requirements compared to a sole proprietorship.
One key advantage of a sole proprietorship is the simplicity and ease of formation. In most cases, all you need to do to start a sole proprietorship is simply start conducting business under your own name. There are no formal registration requirements or filings with the state, making it a cost-effective and straightforward option for small businesses. However, it’s important to note that there is a greater degree of personal risk associated with a sole proprietorship, since the owner is personally liable for any business debts or legal issues.
On the other hand, forming an LLC can provide business owners with added protection and credibility. By separating the business assets from personal assets, an LLC can shield the owners from personal liability and protect their personal assets in case of legal action. Additionally, having an LLC may make it easier to attract investors, secure loans, and enter into contracts, as it provides a more formal and structured business entity.
Ultimately, the decision between an LLC and a sole proprietorship will come down to the individual needs and preferences of the business owner. While an LLC may offer more protection and structure, it also comes with more administrative responsibilities and costs. On the other hand, a sole proprietorship may be simpler and more cost-effective to set up, but it leaves the owner vulnerable to personal risks and liabilities.
In conclusion, both LLCs and sole proprietorships have their own set of advantages and disadvantages, and the choice between the two will depend on the specific circumstances and goals of the business owner. It is important for business owners to carefully weigh these factors and consult with legal and financial advisors to determine the best structure for their individual needs. Ultimately, the right decision will set the foundation for a successful and sustainable business venture.
In Conclusion
LLCs and Sole proprietorships are two different business structures, yet they are similar. Single-member LLCs are similar to sole proprietorships. Even though they are similar, the organizational structure is different for these two types. It is a bit difficult to say which structure to choose, as it entirely depends on your requirements. Both are easy to form and have advantages. It is recommended to go through all the merits and demerits (including tax and other financial benefits) before making any decision.