Can an LLC Be an Individual or Sole Proprietor?

By Michelle Kaminsky, J.D.

Can an LLC Be an Individual or Sole Proprietor?

By Michelle Kaminsky, J.D.

A limited liability company (LLC) is a type of business entity defined by state law. An individual may do business as an LLC in what is called a single-member LLC. A sole proprietorship, on the other hand, is a business owned and operated by one person, but it is neither an LLC nor a corporation.

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An LLC functions similarly to a sole proprietorship in many ways, including federal taxation, if the owner so desires. The main difference between doing business as an LLC and a sole proprietor is that an LLC owner is usually not personally liable for the company's debts and obligations.

Business Formation

A sole proprietorship doesn't require any special paperwork to set up as there are no legal requirements to do so. You can decide to start being your own boss and just do it without registering the business with the state. However, if you want to operate under a name different than your own, you may need to file as a " doing business as" (DBA) with the appropriate state agency, usually the Secretary of State.

To form an LLC, you must follow your state's procedures as outlined on the website of the state agency that regulates businesses. Generally, forming an LLC requires filing articles of incorporation and paying a fee, although some jurisdictions also have additional documentation and fee requirements.

Business Management and Operation

Whether you form a sole proprietorship or a single-member LLC, you are ultimately responsible for running the business. In both situations, you may choose to hire others to help you in whatever capacity you need, and you must always pay special attention to the requirements of the Internal Revenue Service (IRS) for handling tax concerns surrounding employees and independent contractors.

Note that sole proprietors who need to hire employees or independent contractors may consider moving toward forming an LLC because of the limited liability protection such an entity offers.

Federal Taxation

A sole proprietorship passes income to its owner, who is then taxed on his personal income tax return. A sole proprietor may also be responsible for paying self-employment taxes.

An LLC is not a distinct business entity to the IRS, which leaves the decision on how to be taxed up to the owner. A single-member LLC may choose to be taxed as either a corporation or as a sole proprietorship. A corporation's income is taxed at the corporate level while dividends and capital gains are taxed on the recipient's personal income tax return. Many LLCs choose to be taxed as a sole proprietorship to avoid this double taxation.

Note that, regardless of the choice regarding federal taxation, the entity remains an LLC registered under state law. That is, you don't lose limited liability protection by choosing to be taxed as a sole proprietorship by the IRS.

Potential Pitfalls of a Single-Member LLC

In order to keep the limited liability protections intact in a single-member LLC, the owner must take special precautions to ensure the business operates independently from the individual. That means that the business should be adequately capitalized to run on its own and that the owner shouldn't mix personal and business assets. Otherwise, should a lawsuit arise, a court could find that the business is actually a sole proprietorship and strip away the owner's limited liability for the company's debts, leaving the owner personally liable.

Several important choices face individuals ready to go into business for themselves, so it's important to weigh all the options carefully.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.