For entrepreneurs, it is essential to decide which kind of business they want to start. Perhaps this is why they find themselves in so much of a dilemma, especially when it comes to the sole proprietorship vs. LLC. Both these businesses are perfect for small and medium-scale businesses.
However, when we are talking about the corporate level, these two business structures are very different from each other on so many grounds. And that’s the reason why it’s essential to know about these business entities in detail.
On this page, you’ll learn about the following:
What is Sole Proprietorship?
As the name implies, it can be understood that in a sole proprietorship, the owner will have unlimited control on every aspect of the venture, be it the finances, legal matters, taxations, and so on. This kind of business model is unincorporated, which means that the company and the owner won’t be two separate identities. Rather, all the business requirements will be fulfilled under the name of the sole proprietor.
In a sole proprietorship business, there will be no partnership between the members of the company. Rather, there will be only one owner, who will represent the business in every way. Instead of being a separate entity, the organization and the individual owner will be amalgamated together in a way where all the documentation will be formed in your name. In most cases, the sole proprietorship business focuses on a handful of audiences, like the local market, families, and friends. Employees are hired only when the proprietor will get the EIN number and establish a bank account.
The sole proprietorship business will be managed by the business owners only. These are small-scale businesses, with or without employees, because of which being a sole owner wouldn’t cause any trouble for you. Every decision will come from your side, and you wouldn’t have to worry about reaching common ground with other participants in the company.
Finances and Taxation
The business income from a sole proprietorship will base on the total profits earned by the company in a given financial year. Being the only owner, you will earn the entire profits, and it wouldn’t get divided into shares for multiple members. As for the taxes, you need to pay the amount from your business earnings, including the self-employment taxes and the individual tax return. There will be no pass-through taxation benefit for the sole proprietorship business.
Asset Protection and Liability
With this particular business structure, you wouldn’t get the liability protections. Even if the business incurs losses or goes to bankruptcy due to multiple debts, it will be you who needs to handle the responsibility of these issues. Here, your personal liability wouldn’t remain separate from the business assets.
Sole Proprietorship Pros and Cons
While there are significant upsides to setting up a sole proprietorship, there are downsides as well. Here are the pros and cons of a sole proprietorship.
- Allows you to have full control: One of the main reasons for the formation of the sole proprietorship business is the opportunity to have complete control over this type of business. As you will be the sole owner, you won’t have to answer to anyone or provide an explanation against a reform or a decision.
- No legal complications during the formation: You won’t have to worry about facing tons of legal complications when you are forming the business structure. Since it is an unincorporated organization, you can form the company without having to show any sort of important documents.
- Needs little to average capital investment: You won’t have to worry about the initial investment because, in the sole proprietorship business, the business’s finances are very minimal, and hence you won’t have to increase the capital too much.
- Decision-taking time is very low: You will be able to handle the business affairs easily without anyone’s intervention. There will be no need to sit in the meetings with others for hours just to reach one conclusion for the betterment of the companies.
- Can be operated without conflicts of interests: Finally, there’s no need to worry about the differences between the interests of the participating members since being a single-operated company, you will be able to pay attention to your thoughts.
- No protection will be provided to the personal assets in the sole proprietorship companies, which is why you will have to beat the business expenses on your own.
- You will have to pay all the business debts and the loan amounts till the credit is cleared. If not, then the company might go into bankruptcy, causing losses in your personal assets too.
- The individual income tax and the self-employment taxes need to be paid from your own profits, which further reduces the overall earnings.
What is an LLC?
This form of business will offer you complete Limited Liability Protection, because of which most companies are established as a limited liability company only. Here, the business structure is formed in a way where the member/members can receive legal protection for their assets and interests if somehow the business faces issues like debts, lawsuits, and others.
There are two major structural representations for these LLC companies: single-member Limited Liability Company and the multi-member Limited Liability Company. In the former structure, only one person holds the superior authority of the entire organization. However, if the company is formed by multiple partners, the authority will rest in each hand, based on the percentage of ownership.
The LLC business type can be operated in two different ways. If the company is being managed by one or more members, it comes to be known as member-managed LLC. However, there is a possibility where the members assign a third-party manager to oversee the entire company’s functionalities. Under such a scenario, the company is said to be manager-managed LLC.
Finances and Taxation
Whatever money you will earn s being a member of a single-member LLC, it will be your profit, and you will be liable to pay the income and sales taxes based on the business structure mentioned at IRS. However, if you are involved in the multi-member LLC, you will have the profit based on the ownership percentage, and only then will you file the taxation. Hence, such LLCs are said to be pass-through entities. Apart from these taxes, you also need to worry about the pension tax and the payroll taxes.
Asset Protection and Liability
With LLC, you can take help from popular asset protection consultants like FreshBooks to learn about how the LLC will protect your assets from business issues. With the LLC, you will not have your personal assets at risk from the business liabilities.
LLC Pros and Cons
The pros of limited liability companies are quite evident, but it is still worthwhile to check the cons. Here are the advantages and disadvantages of forming an LLC.
- Reduced risks to personal assets: With the LLC, you will be able to enjoy the personal liability protection benefits since here; your assets will be protected. No matter whether the business is facing huge credit debts or on the verge of being dissolved, no harm will come to your asset, which is why this separate business entity is perfect for many entrepreneurs.
- Multiple tax benefits: One of the major reasons for having the LLC company is the tax benefits such a structure offers. Here, you can enjoy the pass-through taxes where you will have to file the report only when you will receive the profits as per the percentage of ownership.
- Flexibility in management: LLC can be operated either by you or by a manager who will be appointed by the members of the company. This has introduced a lot of flexibility in the LLC businesses, which is why it’s far better than the sole proprietorship.
- One of the major disadvantages of the LLC is the payment of self-unemployment taxes to the state government, both for domestic and foreign LLC.
- If the budget is not formed correctly, LLCs can be difficult to operate a lot.
Which is Better LLC or Sole Proprietorship?
LLC is preferred over sole proprietorship because it protects your personal assets in case your business suffers any kind of loss or gets sued.
When deciding whether to form an LLC or sole proprietorship, there are several factors to consider. These include personal protection, tax implications, fees, and ongoing record-keeping. It is also important to consider future needs such as financing or the creation of a new credit record.
While the simplicity of a sole proprietorship may be tempting, it can be risky. An LLC protects you from liability and can be a smart investment if you plan to expand your business. In addition, an LLC is easy to form and relatively cheap to maintain. For example, a Northwest LLC formation costs $39 – far less than an equivalent sole proprietorship formation fee!
Another advantage of an LLC is that members are protected from liability and bankruptcy. If the business goes bust, only the assets of the LLC will be available to pay off the debts. A sole proprietor may be able to buy liability insurance for their business, but an LLC will provide more protection in the event of a lawsuit.
A sole proprietorship requires less paperwork than an LLC, but you’ll still need to pay taxes. Unlike an LLC, a sole proprietorship does not need an EIN. In fact, it can use a sole proprietor’s Social Security number to handle all financial transactions. In addition, sole proprietorships are taxed using the pass-through method, meaning that business profits flow directly into the owner’s personal income on tax time. In addition, sole proprietorships generally require fewer annual fees than an LLC, which must be paid annually.
One downside of sole proprietorships is that there is no legal protection. However, there are some steps that you can take to avoid being held responsible for a mistake. Creating an LLC offers more protection and flexibility, but you will need a qualified accountant to determine the best option for your business.
LLCs do not pay personal income taxes. However, the members of a single-member LLC have to pay self-employment taxes on the profits of the business. An LLC has more members than a sole-ownership does, so tax filing for an LLC may be more complicated. You’ll also need a tax expert to help you calculate your taxes.
One disadvantage of a sole proprietorship is that its owners are personally liable for the business’ debts. The limited liability provided by an LLC makes it more attractive to investors and consumers. Additionally, an LLC allows business owners to use their legal name as the brand name, unlike a sole proprietor, which must use a surname or register a DBA name. In this way, LLCs offer the business owner greater credibility, which is critical for successful business operations.
However, it is important to note that LLCs don’t require separate accounts for business and personal finances. This makes it easier for business owners to keep accurate business accounting records. A sole proprietorship also lacks the ability to sell stock and raise capital, while an LLC can sell shares to outside investors. An LLC may also have more opportunities to expand and grow.
No, the taxation levied on the sole proprietorship company s far different from the LLC since both these companies are formed on different grounds. For example, as a sole proprietor, you need to pay the taxes from the profits. But, as an LLC member, you don’t have to spend your profits to pay the taxes.
Obviously, the sole proprietorship company will always be at higher risks as compared to the LLCs. Hence, you need to be very certain about the type of business you want to establish. If you are confused, you can take help from professional consultants like FreshBooks.
LLCs and Sole Proprietorship are two different business structures yet they are similar. Single-member LLCs are similar to a sole proprietorship. Even though they are similar, but the organizational structure is different for these two types. It will be beneficial to know the pros and cons of both before you start your own business.