Choosing the right business structure can be a daunting task. With so many formations to choose from, how do you know what’s right for your needs? You know you have to weight the pros and cons of sole proprietorship vs LLC, but when do you know what choice is best for your business? For most small business owners and self-employed individuals, that decision is even more complicated. If you don’t have a large number of employees or several owners, it’s easy to get confused quickly.
Sole Proprietorship vs LLC
The most common options today are to start a limited liability company or continue as a sole proprietorship. Both of these are low-cost to start, and they also have a lot of flexible options. However, there is no perfect option that makes sense 100% of the time, so it’s up to you as an entrepreneur to learn about the value of each option.
Why Sole Proprietorship?
Let’s start by analyzing the simplest and most affordable business structure: sole proprietorship. With a sole proprietorship, YOU are the business. Unless you’re doing business under a name other than your legal name, you don’t need to file anything complicated with your state to start your business. The taxes are equally as simple. You include all of the profits and losses within your individual tax return. There’s no need to file separately for your business.
It’s easy to see why so many business owners choose this over more complex structures. It’s simple to hit the ground running, and you don’t have to worry about navigating a complicated tax system. However, there are some major drawbacks to this type of structure.
The biggest problem with a sole proprietorship is the liability. Since you are the business, you’re solely responsible for all legal and tax obligations. That means if you run into a tax problem related to your business, it’s entirely your problem. Similarly, if your business faces legal action, all that responsibility falls to you. Depending on your business, this could be catastrophic.
Why Limited Liability Company?
Now that you understand the advantages and disadvantages of a sole proprietorship, let’s take a closer look at LLCs. Recently, these formations have become increasingly popular. This is likely because they take the best parts of corporations and partnerships and combine them to make a single entity. Under an LLC, you’re sheltered from liability.
If the business faces legal or tax action, this falls solely on the business, not your personal assets. If you’re a single-member LLC, you are taxed the same way as a sole proprietorship with the profits and losses flowing through to your tax return. Under this type of formation, you can also add additional partners without losing the pass-through taxation.
As you can see, the main perk of forming an LLC is not having to worry about the liability falling completely on your personal assets. You’ll also need to keep in mind that these types of structures are more complicated, and you’ll need an official certificate of formation. Depending on your state, this will also come with filing fees. The process is relatively simple, but you might want to work with a lawyer if you’re new to form businesses.
Which is Best?
Ultimately, neither option is inherently better. There are clear pros and cons of each, and what you decide will depend on your unique business. In general, if there’s the potential for a lawsuit or other legal action out of your control, you should form an LLC. For example, if you’re starting a cookie baking business out of your home, you might want to consider an LLC to protect yourself in case something unexpected happens.
On the other hand, if you’re not in a situation where you anticipate any legal action, you might be fine proceeding with a sole proprietorship. These are certainly simpler to establish, and they don’t take any additional time and effort.
The best course of action is to speak with a tax professional and an attorney about the option that’s right for your business. A professional will be able to assess your unique risks, needs, and state tax law changes to help you choose the structure that will be most beneficial to you. This process doesn’t have to be complicated. As long as you know what you want out of your business, you can form the right structure quickly and painlessly.