Starting a business involves choosing the type of legal structure that best fits the needs of your new venture. Small businesses often choose to operate as sole proprietors or to form a limited liability company, or LLC. Both business structures have their pros and cons.
The start-up costs of a sole proprietorship do not involve the numerous registration fees associated with other types of businesses. Outside of any equipment needed to conduct business, you can start a sole proprietorship simply by selecting a name for your business and obtaining any permits or licenses required by your local and state government. LLCs, on the other hand, must register with the state government and pay a filing fee. In some states the filing fee is less than $100, while in others it may be as high as a few hundred dollars or more. Other documents that have filing fees may be required in addition to the registration.
State limited liability laws include numerous rules on how LLCs must operate. LLCs must adhere to naming rules that generally require them to have certain words at the end of their company name, such as “limited liability company.” Some states also require LLCs to form operating agreements, have registered agents that receive service of process documents for the company, and file annual statements or reports. Sole proprietors, on the other hand, do not have to adhere to the naming and paperwork guidelines outside of making sure their name is not the same as another business operating in the state.
One of the biggest differences between a sole proprietorship and an LLC is liability. A sole proprietorship has no protection against debts and other business obligations. As the business owner, you can be held personally liable and your personal assets are vulnerable to any lawsuits, creditors and bankruptcy. For an LLC, liability is limited to the assets of the business. This protects LLC members from having their personal assets seized in the event of bankruptcy or legal judgment.
Sole proprietors include their business income on their personal tax returns. They include a form detailing their profit or loss along with their individual federal income tax return. And unlike other business entities, the IRS does not recognize LLCs as a tax classification. LLCs must file taxes as a sole proprietorship, partnership or corporation. The tax forms filed for LLCs vary depending on how they choose to be classified under IRS regulations.