Pin Me

Sole Proprietorship vs. LLC: Which Should You Choose?

written by: N Nayab•edited by: Jean Scheid•updated: 8/18/2010

When comparing Sole Proprietorship vs LLC, the appropriate business structure depends on individual factors such as the type of business, taxation issues, industry liability, and others. Most business owners begin as sole proprietors, but soon transform to a LLC for a variety of benefits.

  • slide 1 of 7

    Sole Proprietorship vs LLC Sole Proprietorship is the easiest and default mode of business structure where the proprietor represents the business. A Limited Liability Company (LLC) is a relatively new type of hybrid business structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.

    Image Credit: geograph.org.uk/Roger A Smith

  • slide 2 of 7

    Legal Status

    The fundamental difference between Sole Proprietorship and Limited Liability Company (LLC) is the legal status of the business.

    A Sole Proprietorship is an unincorporated or non-registered business subject to little or no government regulation. It is not a separate legal entity, and the proprietor represents the business legally. A sole proprietorship can have only one owner, and infusion of a second owner automatically converts the entity into a general partnership.

    A Limited Liability Company is a regulated legal entity registered by one or more individuals or other entities.

    The proprietor owns all assets of the sole proprietorship whereas the LLC owns the assets.

  • slide 3 of 7

    Taxation

    Tax implications are a major consideration when entrepreneurs perform a trade off between Sole Proprietorship vs LLC for adopting a suitable business structure.

    The income from the Sole Proprietorship finds mention in the proprietor’s personal income tax returns, and self-employed tax implications apply.

    The IRS does not recognize a Limited Liability Company and allows the LLC to opt for taxation as sole proprietorship, partnership, or corporation. The owners file tax returns individually and the LLC files tax returns only for providing information, not to pay taxes.

    Comparing the tax benefits of Sole Proprietorship vs LLC, Sole Proprietorship offers a better tax deal for single owner businesses. A sole proprietor does not have to pay payroll taxes that a corporation has to, and can deduct the spouse’s healthcare reimbursement arrangements when filing self-employment tax. Filing tax returns are easy and uncomplicated for the sole proprietor, but complex and time consuming for corporation.

  • slide 4 of 7

    Personal Liability

    The biggest disadvantage of Sole Proprietorship and the biggest advantage of the Limited Liability Company is personal liability. The sole proprietor becomes personally liable for all debts and actions of the company, including any compensation awarded by the court. The proprietor’s personal wealth, including home and personal accounts, even if not intended for the business, remains connected to the business and open to attachment by the court to recover business related obligations.

    The Limited Liability Company is a separate legal entity and does not create a lien on the business owner’s personal assets. The maximum loss for the business owner is the amount invested in the LLC, or the LLC’s assets. Providing personal guarantees or signing contracts in the name of the owner and not the LLC, however, makes the business owner liable.

  • slide 5 of 7

    Start-Up

    A Sole Proprietorship is easy to set up and requires little or no costs to establish. It does not require a separate registration, and only needs a business license from the local county to start the business. A Limited Liability Company however requires separate registration apart from the business license. Registration of LLC is complex and requires registration filing fees to a public regulatory commission and the services of a lawyer; or you can skip the legal fees and incorporate on your own. Some states also levy business or franchise tax payable annually besides the one time registration fee.

  • slide 6 of 7

    Capital

    Raising fresh capital is difficult for the Sole Proprietorship. Infusion of partners automatically converts the Sole Proprietorship into a General Partnership, and most banks or other investors remain reluctant to extend loans to an unregistered entity such as a Sole Proprietorship or General Partnership. Taking private funding complicates the tax return, as the fresh source of funds needs to explore some accounting detail. The only option remains taking out a consumer loan, the success of which depends on the credit history of the proprietor.

    Raining funds is easier for the Limited Liability Company. A LLC can easily offer fresh membership units to raise capital. Banks and other investors remain ready to offer loans to a LLC provided the entity can offer collateral security and has a sound business plan. Banks look at the credit record of the company rather than that of the owners to determine credit-worthiness.

  • slide 7 of 7

    Exit Policy

    A Sole Proprietorship ends when the proprietor decides to quit doing business. A sole proprietor can sell the business, but conversion of sole proprietorship to corporation attracts tax implications.

    The liquidation of the Limited Liability Company depends on the operating agreement. Members of the LLC can quit by transferring their shares instead of shutting down the business, ensuring the continuity of the LLC.






© Copyright 2016 brighthub.com.