Whether you’re setting up a small business, opening an online store, or starting a career as a freelancer, you’re faced with this question: should you pick a sole proprietorship or LLC?
Sole proprietorship and LLC (Limited Liability Company) are two business models that can make a huge difference in how you run your business. That’s especially true when we’re talking about your management, legal compliance, and tax requirements. So today, we’ll help clear things out. Here’s what you need to know about LLC and sole proprietorship.
A sole proprietorship is an unincorporated business with a single owner. Any individual who runs their own business is, by default, a sole proprietor until they choose to adopt another business structure. It’s the simplest business structure to form, but there’s a downside to a sole proprietorship: the business is not legally separate from the owner. That means the owner is responsible for the business’s finances, including debts and obligations.
Still, many individuals that run small companies or do contractual work, like freelancers and consultants, choose to be sole proprietors. It’s the least expensive business structure, especially in terms of business tax, which is a huge help if they’re starting out or not yet making lots of profit.
A Limited Liability Company or LLC is a legally separate business entity. You can form a single-member LLC or multi-member LLC if you have multiple business partners.
The defining characteristic of an LLC is it protects owners from the business’s debts and obligations. Creditors can’t come after the owners’ personal assets in case of business loan defaults and other similar situations. Also, an LLC’s bankruptcy is separate from the owner’s.
When it comes to tax, single-member LLCs are usually taxed like sole proprietorships. Multiple-member LLCs have the flexibility to choose the most cost-effective tax structure for their business; they can either elect to be taxed as an S corporation or a C corporation.
To help you decide better, here are the key differences between sole proprietorship and LLC in terms of formation, taxation, legal protection, paperwork & compliance, and operations.
Sole proprietors only need to register their name or trade name and obtain the necessary permits. LLCs have to do the same. But they also need to file articles of organization. It is a crucial document that establishes the LLC’s existence. The cost of filing this document varies by state but generally ranges from $50 to $200.
As the only owner, a sole proprietor has the final say on all business decisions. On the other hand, LLC owners can share the decision-making or appoint a manager to make the final say for the LLC.
Sole proprietors only need to pay taxes and renew business licenses to stay compliant. LLCs have more compliance responsibilities. Other than paying taxes and renewing licenses, an LLC has to file an annual report. Multiple-member LLCs may also need to have an operating agreement, hold member meetings, record membership units, and more.
Sole proprietors are personally responsible for business debts, while LLCs are not.
Sole proprietorship involves pass-through taxation, while LLCs can do the same but also has the flexibility to elect corporate tax status.
If you need more information about taxation and accounting associated with sole proprietorships and LLCs, don’t hesitate to reach out to AccountantsNow. We’re ready to guide you in your business formation and help you stay compliant with tax requirements.
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