The main benefit in organizing your business as an LLC instead of a sole proprietorship is that LLCs offer limited liability. Members of an LLC typically are not personally liable for the debts of the business. If the LLC is sued, goes bankrupt, or cannot pay its debts, the members' personal funds are not at risk. However, some states do not allow for single-member LLCs, meaning that an LLC is simply not an option if you are the sole owner of the business.
LLCs enjoy "pass through" taxation. Instead of the business entity itself paying income tax, the profits are passed directly through to the members, who report the income on their personal tax return. Because the IRS does not recognize an LLC as a business entity, members, by default, will pay taxes as if they were a sole proprietor. A single-member LLC does not pay business tax at the federal level, and in most states, there is no business tax for single-member LLCs.
Like a sole proprietor, the member of a single-member LLC has complete control over how the business is operated. The member may make all business decisions independently and receive the full share of distributed profits. A single-member LLC does not have to deal with shareholders or a board of directors as a corporation would be required to do.
One downside of an LLC over a sole proprietorship is increased paperwork and maintenance at the state and federal level. Many states do not require sole proprietorships to register with the state, but LLCs are usually required to file articles of organization. Similarly, many states require LLCs to file an annual report, which sole proprietorships are not responsible for. If the LLC closes, the member usually must notify the state that the business has dissolved.
Despite the increased paperwork, an LLC is less formal than a corporation. A corporation generally involves a board of directors, and shareholders who are legally responsible for the business. The informality of an LLC makes it harder to get credit, raise equity capital and establish a value for the business than if it was organized as a corporation. When applying for a loan or establishing a line of credit with a bank, the bank will look at how the business is structured and how contributions and profits are dispersed among owners. With the risk distributed among shareholders, as opposed to a single owner, a bank may see a corporation as less risky for lending.