Limited liability companies, or LLCs, and sole proprietorships are two different forms of business. For a new owner starting a business, the choice of form is a very important decision. People thinking about creating a business should seek professional advice.
A sole proprietorship is a very basic form of business in which the proprietor and the business are basically considered identical. The business is not a separate entity, as it is with a corporation or an LLC. For this reason, the sole proprietorship form only works when there is a single owner. Owners often prefer sole proprietorships, particularly small businesses, because it requires minimum expense and difficulty to set up. Typically, no state forms are required; however, local governments may require sole proprietors to follow certain formalities.
Limited Liability Company
Unlike a sole proprietorship, a limited liability company is considered a separate entity from its owners. These owners, typically known as members, create an LLC by registering the business entity with the appropriate regulatory agency, often the Secretary of State. Although not required by most states, members may also draft and sign an operating agreement that ideally spells out every detail of the members' responsibilities and how the LLC will conduct itself. There are very few set rules for the operation of an LLC, other than those detailed by state law. This makes the LLC an appealing business form for those who need flexibility in the operation of the business. However, the LLC is a more complex business form than a sole proprietorship.
One of the biggest differences between the sole proprietorship and the LLC is the limitation of liability. A sole proprietor is personally liable for any debts or other liabilities incurred in the operation of the business (lawsuits, financial debt, etc.), meaning that creditors can go after the proprietor's personal assets to satisfy the business debts. An LLC, by contrast, is a financial entity separate from its owners, and only the entity's assets may be used to satisfy most business liabilities. None of the LLC members are personally liable. This "limited liability" makes the LLC attractive to business owners who may anticipate business or financial risk in operating the business. Although liability is limited, it is not entirely gone; certain egregious acts can "pierce" the limited liability and allow a creditor to hold a member personally liable.
Unlike corporations, which are taxed separately from the personal taxes of the corporation's owners, both LLCs and sole proprietorships enjoy what is known as "pass-through" taxation, meaning the sole proprietor or LLC member is taxed only once, personally, on his profits from the business. Typically, neither the sole proprietorship nor the LLC itself is taxed as a separate entity by the IRS. This can be an enormous advantage to business entities seeking to avoid corporate taxation.