Knowing whether to set your business up as a Sole Proprietorship vs LLC is tricky. Both are popular options for small business owners and entrepreneurs.
When it comes to LLC vs Sole Proprietorship, both structures have perks. The right choice for your business will depend on many factors we will share in this article.
Read on to understand the pros, cons, and differences between sole proprietorships and limited liability companies.
We’ll also look at what’s required in the setup process and how you can scale your business as an LLC vs Sole Proprietor.
Sole Proprietor vs LLC Definitions
New entrepreneurs will likely never have heard of an LLC vs Sole Proprietorship. Even if you have, it’s unlikely you’re thought long and hard about which is right for your business.
It might not be until you start hiring staff or filing tax returns that you really start to think about it. Setting up as a sole proprietor vs LLC can impact your tax implications and legal standing.
Below, we’ve detailed the difference between LLC and Sole Proprietorship.
What Does Sole Proprietorship Mean?
A Sole Proprietor is a business owned and managed by a single individual. They can only have one owner, and this owner is self-employed. If things go well, and you want to bring in a second owner, the business will change to a partnership.
A sole proprietorship is one of the most common business structures for startups. They’re incredibly quick and simple to set up. Government regulation sees you and your business entity as the same, so there’s no need for extra paperwork or separate tax reports.
As the business owner, you hold all liability for the business. That means any personal assets you have are now at the liberty of your business. If your business gets sued or falls into debt, it’s your personal assets that take the hit.
You might already be a sole proprietor without realizing if you’re in the gig industry or working as a freelancer or consultant.
What Is A Limited Liability Corporation (LLC)?
A Limited Liability Corporation offers personal liability protection. Government regulation sees LLCs as separate entities, so your personal assets are not linked to the business.
LLCs offer flexibility for tax filing, operations, and internal management structures. They can be owned by a single person (single-member LLCs), or have multiple owners known as members.
If your business gets sued or has to file for bankruptcy, your lifestyle and assets are protected. This is a major benefit for anyone that has already worked hard in life to get a certain lifestyle they want.
Nobody wants to get sued, but if a member of your workforce causes legal action to be taken, it’s good to know that you’re not liable.
Setting up as an LLC is a good idea for anyone in a high-risk industry. Although there’s more paperwork, you shouldn’t need a lawyer to help you apply. Your state department will have everything you need to apply.
LLCs require a separate bank account. This is to keep business funds and personal finances separate. All transactions should be done through this account, and invoices and contracts should be signed on behalf of the business.
If you’re setting up a partnership, make sure you lay out an operating agreement from the get-go. This will outline each person’s share of the profits and their voting rights.
You can tell a business is an LLC as its name will end with ‘LLC’.
The Pros and Cons Of A Sole Proprietorship
Setting up a business as a sole proprietorship vs LLC is ideal for freelancers. The structure offers plenty of benefits, but there are a few cons to be aware of.
Pros of Sole Proprietorship
1. Quick and Simple Set Up
Government regulation sees you and your business entity as the same. There’s very little required to get started. Less paperwork and fewer start-up costs mean you’re free to get earnings as quickly as possible.
Most business structures require you to have a separate business bank account. As a sole proprietor, you don’t even need this. It’s as easy as getting started in a single afternoon.
2. Complete Control of Your Business
Sole proprietors are in control of everything to do with their business. Decision-making is flexible, and there are fewer compliance regulations you need to follow.
Cons of Sole Proprietorship
1. Difficult to Secure Funding
Setting up as a sole proprietorship vs LLC can make it more difficult to secure funding. To banks, sole proprietors are single people. With an LLC, there’s a level of legitimacy that comes naturally. Businesses that need inventory or upfront investment may want to set up an LLC instead.
2. No Option to Sell Stocks and Shares
Sole proprietors can’t sell shares of their business.
3. You’re Liable
Your personal assets are entirely linked to your business, the good and the bad. You are liable for anything that goes wrong on the business side. That might be going into debt or getting sued.
The Pros and Cons Of An Limited Liability Company LLC
Just like a sole proprietorship, LLCs come with their own set of pros and cons.
Pros of An LLC Company
You can identify an LLC business because its trade name will end in ‘LLC’ on all official documentation. Those three letters offer a sense of legitimacy that some people look for. Whether that’s a client, a stakeholder, or an investor.
Those who own an LLC vs Sole Proprietorship may find it easier to get a loan from the bank or an investor. They can also establish business credit – something a sole proprietor can’t do.
2. No Crossover of Assets
As mentioned above, there’s no crossover between you and your business. That means you have personal liability protection. If you’ve worked hard to buy a house or your dream, these assets are all safe from the liabilities of your company.
If something bad happens in your business, your lifestyle isn’t affected. For LLCs that hire others, you can rest assured your personal assets are protected from the actions of your employees.
3. Tax Flexibility
You’ll see below that LLCs have options when it comes to how they pay taxes. There’s also flexibility about how to operate and how you set up your management structure.
LLC owners can choose to be taxed as an S corporation, which provides certain tax benefits such as reducing self-employment taxes.
Cons of An LLC Company
1. Setup is more complex
To set up an LLC vs Sole Proprietorship, you’ll need to complete a lot more paperwork. There are also more start-up costs and yearly fees.
2. LLCs are regulated at state level
If you want to do business in multiple states, you’ll need to apply to each state’s authority. Different states have compliancy rules, too, which can make the setup even more complex.
LLC vs. Sole Proprietorship Taxes
The big question most people have when setting up their business is about tax. When launching your business, tax feels overwhelming and complicated.
To help, we’ve broken down how to tax a Sole Proprietorship Vs. Limited Liability Company. However, we would always recommend you speak to a tax professional.
Sole Proprietorship Tax Explained
Business income from a sole proprietorship is reported on your tax return. All taxes owed by the business will be your responsibility to pay.
As the owner, any income is classed as your own self-employment income. It’s therefore subject to self-employment tax (self-employment tax includes medicare and social security). To file business taxes, the owner fills in a Schedule C (Form 1040) to report the net income or losses of the business.
Sole proprietors will also need to pay any local business taxes required in your state.
Limited Liability Company Tax Explained
There are three ways to pay tax as an LLC:
- As a sole proprietorship
- A partnership
- A corporation.
There’s very little difference between Single-Member LLC vs sole proprietorship taxes. You will pay self-employment tax to the IRS to cover social security and medical.
If you take on more owners, each owner will have to report their own taxes based on how much of the business they own. This is done through a K-1 form attached to your personal tax return. You’ll also need to file a total business tax return with the IRS.
LLCs can also choose to restructure their tax payments by applying to be an S or C Corp by filling in a 2553 Form via the IRS. Setting up as an S Corp can help entrepreneurs save money on self-employment tax.
A C Corp setup means the company will pay Corporation tax at a federal level. This would then make the owner an employee of the company rather than being self-employed. Owners of C Corps can often save on self-employment taxes and potentially put more away for retirement. It also means the dividends of the business can be taxed at a reduced rate.
Both LLCs and Sole Proprietors have to pay payroll taxes for any employees and any local taxes for goods and services. LLCs may also be liable for franchise and business taxes, depending on your state.
It is always best to consult a tax professional or financial advisor to ensure you’re filling in your tax returns correctly.
How To Set Up A Sole Proprietorship
Setting up a Sole Proprietorship vs LLC is easy – there’s very little paperwork and no upfront costs. If you’re already a freelancer or working on ad-hoc contracts, you’re probably already a sole proprietor without even realizing it.
Some states will need you to apply for a business permit, and you may want to set up business insurance. But other than that, you’re all set up.
For those trading under a different name – for example, if you’re launching an online store – you will need to complete business name registration with a DBA (Doing Business As) certificate.
With all that done, you’ve got yourself a business. Now it’s time to scale!
How To Scale A Sole Proprietorship Or LLC
So, you’ve decided between an LLC vs Sole Proprietor; how do you now scale your business? Scaling a business can be challenging, but with the right strategies in place, it’s much easier. If you’re looking to get started straight away, here are a few things we recommend setting in place.
1. Create a Business Plan
No business can function without direction. Create a business plan to help you understand who your audience is and how you will attract them. Set goals for your business and break down how you’ll achieve them through different objectives. For serious scaling, you might also want to set deadlines for different objectives.
2. Invest in Marketing
The only way to scale your business is to put money where your mouth is. Marketing can feel like a massive upfront cost, but without an audience, you can’t gain custom.
It’s important to invest and re-invest in marketing for your business. This will create a consistent funnel of new clients and increase brand awareness.
For those looking for rapid scalability, you may want to work with a marketing agency specializing in your field.
3. Expand your Product/Service Offering
Once you’ve established one good idea, product, or service for your business, get busy with the second. Expanding your offering allows you to attract new audiences and upsell to existing customers.
4. Look for Funding
Some business scaling will need upfront investment. Securing funding is a great way to kickstart your journey. Hiring staff, using paid marketing, and trialing new products all come at a price. Securing funding gives you the flexibility to boost your business output.
5. Seek Mentorship
Ask for help from professionals that have already been through the scaling experience. Speak to accountants, lawyers, and business consultants for inspiration and guidance. You can also work with agencies and companies that help you to develop systems to scale your business operations, like client acquisition. That’s what we do here at Scaling With Systems.
Scaling any business requires planning, patience, and determination. It also requires a willingness to take a few risks along the way. Following these tips, you can increase your chances of success.
Sole Proprietorship vs LLC: FAQs
Can you convert a sole proprietorship to an LLC?
Yes, you can start your business as a sole proprietor and later convert it into an LLC. To do this, you must submit the correct paperwork to your secretary of state or local business bureau. Setting up an LLC costs, so you will need to account for these in your business expenses.
Is an LLC better for taxes?
Whether an LLC is better for taxes is completely dependent on your business. As standard, a single-member LLC vs sole proprietorship is taxed similarly and is reported on your personal tax return.
However, LLCs can also choose to be taxed as an S or C corporation. This may allow the company to reap certain benefits, like reducing self-employment taxes for owners. We recommend speaking to a financial advisor before making any tax decisions.
Can a sole proprietor be an LLC?
No, but sole proprietors can convert their business into an LLC. Business owners tend to switch to an LLC once they start to make a profit or if they have personal assets they want to protect. Once the conversion is complete, the business can then have multiple owners.
What is the difference between a sole proprietorship & an LLC?
A sole proprietorship is a business structure in which one individual owns and operates the business. The owner handles all debts and liabilities. A Limited Liability Company can have multiple owners, and debts aren’t linked to the owners themselves. An LLC gives business owners a little bit of personal protection.
Wrapping Up: LLC vs Sole Proprietorship For Your Business
LLCs and Sole Proprietorships are both great business structures for getting started. Each has its own set of benefits, and choosing the right structure for your business will completely depend on the type of work you’re doing and how quickly you want to scale.
Setting up a Sole Proprietorship vs LLC is great for beginners. It’s less risky, and if your profits are quite low, you won’t have upfront costs to account for. Generally, if your profits are less than $50k, a sole proprietorship works fine.
When you start to think bigger and want to expand your business, you can convert to an LLC. This allows you to bring on new owners, take advantage of certain tax options and separate the business’s liabilities from your own. The bigger the company, the higher the chances you’ll have legal complications with clients or suppliers.
Whether you’re an LLC vs Sole proprietor, Scaling With Systems can help save you time as you scale your business. Book a free consultation call, and one of our experts will work with you on a customized plan to help you achieve your goals.