An LLC vs. Sole Proprietorship

By Cindy DeRuyter, J.D.

An LLC vs. Sole Proprietorship

By Cindy DeRuyter, J.D.

When establishing a new business as a solo venture, an entrepreneur must decide which type of business entity to create. Two common choices are sole proprietorships and limited liability companies (LLCs). Each comes with certain potential advantages and drawbacks, so entrepreneurs should weigh their options carefully and choose the entity structure that best meets their needs.

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Ease of Establishment

Both sole proprietorships and LLCs are relatively easy to establish. Because state laws govern the creation of business entities, someone interested in starting a business should check with their Secretary of State or other business agency to determine what steps to take.

In some jurisdictions, sole proprietorships must register with the state or county where the business operates. Others don't require registration. However, if the business owner wishes to use a name other than their legal name for marketing or other purposes, they must register a "doing business as" (DBA) name. Some states call this a fictitious business name or an assumed name.

To establish an LLC, the business owner must file a document called "articles of organization" with the state or county and pay a fee. Depending on the nature of the business and state, county, or city regulations, some sole proprietorships and LLCs must also obtain certain licenses and permits before beginning operations. However, neither LLCs nor sole proprietorships require the formalities associated with corporations. Because of this, they are often more attractive than corporations for individuals starting new ventures.

Personal Liability Protection

One way in which sole proprietorships and LLCs differ is in the owner's liability for the business's obligations. Sole proprietors are personally responsible for any and all debts and other financial obligations their businesses incur. This means their personal assets are at risk if someone sues the company or if the company is otherwise unable to meet its financial obligations.

LLCs limit owners' liability for their business debts and other obligations. Generally speaking, an LLC owner's assets are only at risk to the extent of their investment in the company. Their home, retirement account, bank accounts, and other assets are off limits to the business' creditors. In limited cases, courts may decide to "pierce the veil" and attach personal liability to an LLC's owner, but these situations are the exception rather than the rule.

Tax Treatment

Both single-member LLCs and sole proprietorships receive similar default federal tax treatment. Neither one files, calculates, or pays federal income tax at the company level. Instead, they are both pass-through business entities. This means that profits and losses pass to owners, who report the information on their individual income tax returns.

When evaluating options to create a new business entity, it's important to choose an entity type that meets your needs today. However, it is also important to choose a structure that can grow with your new business. For help determining whether a sole proprietorship or an LLC is right for your business, you can consult with a tax professional or a business law attorney licensed to practice in your state.

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