What is the difference between a business being sole proprietor and a Limited Liability Company (LLC)? (2024)

FAQs

What is the difference between a business being sole proprietor and a Limited Liability Company (LLC)? ›

A sole proprietorship is a business that's owned and operated by one person, while a limited liability company (LLC) can be formed by an individual or a group of entrepreneurs. Each has their own unique benefits as an effective business structure.

Typically, an LLC taxed as a sole proprietorship pays more taxes and S Corp tax status means paying less in taxes. By default, an LLC pays taxes as a sole proprietorship, which includes self-employment tax on your total profits.

This preference doesn't extend to sole proprietors, who are considered riskier investments than LLCs or corporations. As a result, you could struggle to access business funding as a sole owner. To get funding for your venture, you may need to take out personal loans, which have their own pitfalls.

The Small Business Administration defines a sole proprietorship as an unincorporated business owned and run by one individual, with no distinction between the business and the owner. The sole proprietor is entitled to all profits and is personally responsible for all the business's debts, losses, and liabilities.

The main benefit for sole proprietorships and partnerships is pass-through taxation. The business does not file income taxes. Rather, all income, losses, deductions, and credits pass through to the owners and are filed on their personal tax returns.

As an entrepreneur testing the waters, a sole proprietorship may be an easy and cost-effective option, while a fast-growing business that needs funding would be better suited to an LLC.

You can save more on taxes as an S corporation owner because you have more options for reducing your self-employment tax liabilities.

Choosing to be a sole proprietor vs LLC doesn't directly have anything to do with taxes. Even if you form an LLC, you'll continue to pay taxes as a sole proprietorship, where the profits pass through to the owners' personal income. This is the default tax treatment for single-member LLCs.

The conversion of a sole proprietorship into a single-member LLC (SMLLC) is accomplished by filing a certificate of formation (or other required document), paying the appropriate fee, and executing articles of organization and an operating agreement (if required).

The LLC's members are not held personally liable for business debts or other liabilities incurred by the business, such as lawsuits, accidents, or injuries. Instead, the LLC is responsible. A sole proprietorship, on the other hand, is always owned and operated by only one person.

What is the main disadvantage of being a sole proprietor? ›

Among one of the biggest disadvantages of a sole proprietorship is unlimited liability. This liability not only spans the business but the business owner's personal assets. Debt collectors can access your savings, property, cars, and more to see a debt repaid.

Yes, you can change your EIN from your sole proprietorship to an LLC, but you will have to obtain a new EIN. To change your EIN from a sole proprietorship to an LLC, you must complete Form SS-4, Application for Employer Identification Number, available on the IRS website.

Does a small company that operates as a sole proprietorship need an employer identification number (EIN)? A sole proprietor without employees who isn't required to file any excise tax return and hasn't established a pension, profit-sharing, or retirement plan doesn't need an EIN (but can get one).

An LLC will need an EIN if it has any employees or if it will be required to file any of the excise tax forms listed below. Most new single-member LLCs classified as disregarded entities will need to obtain an EIN. An LLC applies for an EIN by filing Form SS-4, Application for Employer Identification Number.

Yes, a single-member LLC will protect your personal assets just as a multi-member LLC will. Forming an LLC is an important step for single-member businesses and will help create the necessary separation between your personal and business assets.

Sole proprietors can and do employ people. Many start with family members, but hiring people, whether the person is a relative or not, adds another layer of complexity to business management. Sole proprietors will need to pay their employees, file and remit payroll taxes, and comply with employment regulations.

A sole proprietor is not eligible to file as an S corp. A sole proprietor must first incorporate as an LLC or C corp before electing S corp tax classification.

Because of the limited liability concept, you may consider switching from a sole proprietorship to an LLC if you're concerned about your personal property being subject to a lawsuit against your business.

To be taxed as an S corporation, you must convert your LLC into a traditional corporation (C corporation) with the state, and file IRS Form 2553 "Election as a Small Business Corporation" with the IRS. For your business to qualify as an S corporation, make sure it meets the IRS's specific guidelines.

One person can form an S corporation, while in a few states at least two people are required to form an LLC. Existence is perpetual for S corporations. Conversely, LLCs typically have limited life spans.