Differences Between Llc And Sole Proprietorship
There are important differences between LLCs and sole proprietorships. The most significant difference is whether you have limited liability for the business debts and obligations, as with an LLC, or whether the business liabilities and obligations fall to you personally in the event of a lawsuit or debt collection.
An LLC has distinct advantages in the areas of legal protection and liability. While there are filing fees for setting up an LLC, that cost can be well worth it when compared to the thousands of dollars you could be liable for as a sole proprietor.
On the other hand, it costs no money to start a sole proprietorship. You can also transition into an LLC or other formation option whenever youre ready. This also means dissolving your business is as simple as stopping operations .
Finally, while sole proprietorships have very few regulatory requirements, LLCs are associated with a variety of fees and filings, both initially and ongoing. This can be difficult to manage on your own, which can lead to missing important filings and, in return, incurring penalties.
Does Having A Single
No, having a Single-Member LLC doesnt help reduce taxes. It also doesnt increase your taxes.
Remember, Single-Member LLCs taxed as Sole Proprietorships have pass-through taxation. This means income from the LLC is filed on your personal tax return.
Said another way, your taxes are the same whether or not you have an LLC.
Lets Say Youre A Sole Proprietor When Should You Shift To An Llc
In general, most lawyers are going to recommend that all businesses operate under the protection of limited liability, so it is rare that we would recommend someone operate as a sole proprietorship and not form an LLC . LLCs protect the owners from claims against the business and few lawyers want to bear the risk of that liability by telling a client, Dont worry about it. Im sure everything will be fine.
However, when evaluating the degree of risk faced by an entrepreneur operating as a sole proprietorship, the big question is, Are you in the kind of businesses that exposes you to liability? For example, a graphic designer has much less exposure to potential liability than someone who operates a rock climbing business.
The most common reason that someone forms an LLC is limited liability and the protection an LLC provides for the owner from claims against the business. However, there are two other reasons I see that lead people to form LLCs: tax benefits and credibility.
If I go to a yoga studio, I dont care if they formed an LLC or not.
The third reason people form LLCs, which I just call credibility, is an interesting one. Some businesses, although not all, benefit from the legitimacy that other businesses associate with a formal entity. Of course, with some businesses, credibility is not an issue. If I go to a yoga studio, I dont care if they formed an LLC or not.
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Costs To Renew And Maintain
A sole proprietorship requires the least amount of paperwork prior to launch. After launch, a sole proprietor only needs to keep up with federal, state, and local taxes. In addition, a sole proprietor might need to renew relevant business licenses and permits.
LLCs have more compliance responsibilities. After filing initial Articles of Organization, an LLC must file an annual report in many states. LLCs with multiple members have even more responsibilities, such as drafting an Operating Agreement, issuing membership units, recording transfers of ownership, and holding member meetings.
While none of these steps are legally required, theyre all highly advisable to help LLCs preserve their members liability protection. Since an LLC is a registered business entity, dissolving an LLC takes additional paperwork. An LLC with a corporate tax status also is eligible for more tax deductions and credits.
Powerful Reasons Why Llc Is Better Than Sole Proprietorship
As a brand new entrepreneur ready to face the world, you are going to find yourself going head-to-head with a lot of challenging decisions.
One of the most challenging question youre going to face is whether you should start your business as a sole proprietorship or LLC
This is a question I hear quite a LOT as a business lawyer.
Its a hot topic because, and entrepreneur, like you, should get the right information to make the smart decision.
In summary, sole proprietorship is the simplest business entity, but it requires that you take personal responsibility for all business matters.
On the other hand, LLC protects your personal assets from business debts and lawsuits. What this means is that if something happens to your business then your personal assets such as personal bank account, car, and home will be protected.
The first thing successful entrepreneurs do is form an LLC and as a Business Lawyer for Entrepreneurs, I highly recommend having a registered LLC before you start your business.
If youre still not sure about whether LLC is right for you, email me at with some information about the business youre looking to start and I will tell you whether LLC is the right choice for you.
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Theres A Lot Of Talk Especially In California About The Rights Of Independent Contractors Versus Employees If Freelancers Feel Like Theyre In An Iffy Situation What Are Some Things To Know
Most new business would prefer to treat workers as independent contractors , so that the businesses can avoid employee costs and taxes , but it isnt necessarily up to the employer or even the individual providing services.
The distinction can be very tricky. The law focuses on the nature of the work performed and how that work fits into the employers business. The traditional test for whether someone qualifies as an independent contractor turns on how much control the employer exercises: if the employer just requires a particular result, then the worker can often be treated as an independent contractor. If the employer has the right to control the manner and means by which the worker accomplishes that result, then it is likely that the worker must be treated as an employee.
There was a recent California Supreme Court decision that added additional confusion to this test. It added another category so that if a worker performs a task that is the same type of work performed by the business that worker must be treated at least for some purposes as an employee, even if the employer does not exercise control over the performance of the work. These rules can be very complicated and expensive to comply with, and businesses need to be careful that they have proper guidance or they can get into trouble. On the other hand, some freelancers may have more rights and be entitled to more money than they thought, so they might want to look into their rights as well.
What Is A Sole Proprietorship
A sole proprietorship is the most common business structure and the simplest to form. Sole proprietorships are unincorporated businesses. Legally speaking, there is no distinction between you and your company. You become a sole proprietor by simply conducting business.
If youd like to operate a sole proprietorship using any name other than your given name, youll need to get a “doing business as” name. This will allow you to use an assumed name to enhance the credibility of your business and provide some privacy.
Sole Proprietorship Taxes
Tax season is simple with a sole proprietorship just like an LLC. Sole proprietorships only have one tax option though, which can limit the ways a business owner can save on taxes.
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What Is Asingle Member Llc
A limited liability company is a type of business entity. You form an LLC by filing a document called articles of organization with your state’s business filing office. In most states, this is the Secretary of State’s office. For details, see Nolo’s article “How to Form an LLC.”
All states allow LLCs to be formed, owned, and run by just one person. LLC owners are called members thus, one-owner LLCs are called single-member limited liability companies, or SMLLCs for short. Any independent contractor can form an SMLLC to own and run a one-owner business.
Like a corporation, an SMLLC is a separate legal entity. It can own property, open bank accounts, hire employees, borrow money, enter into contracts, sue and be sued, and do anything else in the business world that a human can do. The owner of an SMLLC runs the business and manages the LLC. But the owner is ordinarily not an employee of the SMLLC. Rather, he or she is a self-employed business owner–the same as a sole proprietor. This means the SMLLC doesn’t have to comply with the payroll tax, labor law, and other legal requirements for employees.
Single Member Limited Liability Companies
A Limited Liability Company is an entity created by state statute. Depending on elections made by the LLC and the number of members, the IRS will treat an LLC either as a corporation, partnership, or as part of the owner’s tax return . A domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and elects to be treated as a corporation. For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and affirmatively elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.
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Management Structure Of S Corporations
In contrast, S corporations are required to have a board of directors and corporate officers. The board of directors oversees the management and is in charge of major corporate decisions, while the corporate officers, such as the chief executive officer and chief financial officer , manage the company’s business operations on a day-to-day basis.
Other differences include the fact that an S corporations existence, once established, is usually perpetual, while this is not typically the case with an LLC, where events such as the departure of a member/owner may result in the dissolution of the LLC.
LLCs and S corporations are business structures that impact a company’s exposure to liability and how the business and business owner are taxed.
Get Yourself A Tax Id And Understand Tax Implications
Once youve decided what kind of business entity you are going to be and where you want to incorporate, its time to get a tax ID number . This means the IRS will recognize you as a business and allow you to pay your state, federal and local taxes. Yay!
This service is free, so if you are being charged for applying, beware!
The best way to apply for a tax ID number is online through the IRS website. Youll be asked a series of questions, and upon validation youll receive your official EIN.
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Smllc’s Provide Tax Flexibility
SMLLC’s have another attribute that is often underappreciated: They provide great flexibility in deciding how a business will be taxed. The default form of taxation for an SMLLC is as a “disregarded entity.” This means the IRS ignores the SMLLC and treats it the same as a sole proprietorship for tax purposes. The SMLLC’s owner files IRS Schedule C to report the business’s income and expenses. Any profits are passed through the business to the owner’s personal tax return. The owner pays tax on the profit at his or her individual tax rates.
However, SMLLC owners have the option of having their business taxed as a regular C corporation or S corporation. This is easily accomplished by filing a document called an election with the IRS. Once this is done, the SMLLC is treated the same as a corporation by the IRS. The SMLLC files the same tax forms as a corporation and is subject to all the corporate tax rules. Independent contractors who are sole proprietors do not have this option.
If My Llc Is A Sole Proprietorship Are My Personal Assets Still Protected
Remember, your LLC isnt a Sole Proprietorship. Its just taxed like a Sole Proprietorship.
The reason an LLC is taxed like a Sole Proprietorship is because there is no LLC tax classification with the IRS. Meaning, the IRS doesnt tax an LLC like an LLC.
Instead, they tax LLCs under already existing classifications . And for Single-Member LLCs, the classification that the IRS automatically uses is Sole Proprietorship taxation.
Said another way, your LLC is still an LLC . Its just that the IRS is treating your LLC like a Sole Proprietorship for federal tax purposes.
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Registering The Business Name
Sole Proprietorship In a sole proprietorship, the business owner IS the business. If the business will operate under a name other than the owners legal name, the owner must file a Doing Business As . For example, if John Wilcox operates his business as John Wilcox Plumbing and Heating, he will not need to do a fictitious name filing. If, however, he wants to call his business, West End Plumbing and Heating, he will need to submit the fictitious name to the state for approval. Some states also require advertisements or notices be run in a local or legal newspaper to disclose to the public who is operating the business under the DBA.
Limited Liability Company When registering an LLC, the business name is automatically registered when formation documents are filed. In some states, its possible to reserve a name in advance of formally registering the business. Name reservations expire after a certain amount of time if not renewed or if business registration isnt completed. Most states require an LLC to include the designation of LLC,Limited Liability Co.,Limited Liability Co. or some other identifier after its name.
Find The Ideal Structure For Your Business
Clearly, there are many factors to consider when choosing the best legal structure for your business. For cost, simplicity, and control, the sole proprietorship is the clear winner. But the LLC has the edge for risk management and flexibility.
Both structures qualify for pass-through taxation, with additional tax options available to LLCs. If you consider all of these factors, and talk them through with your financial, insurance, and legal advisors, you can ensure that your small business has a firm foundation for your biggest plans.
The Motley Fool has a Disclosure Policy. The Author and/or The Motley Fool may have an interest in companies mentioned.
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You Also Get A Sense For Their Goals Right
I try to get a sense of the likely trajectory of the business. One of the questions I ask is, If this is successful not win the lottery successful, but if this business achieves what you want it to how much money will it make?
Some people would want a business to make $200,000 a year and they would be thrilled. Some want a million dollars. Some want it to be like Google. Those different goals push us in different directions.
Similarities Between Llcs And Sole Proprietorships
When comparing LLCs and sole proprietorships side-by-side, its important to recognize that these two business structures share some commonalities.
Heres a quick list of the similarities between LLCs and sole proprietorships:
- Income and expenses must be reported in Schedule C Form 1040.
- Net income is taxable, regardless of whether or not cash is withdrawn from the business.
- They have similar rules for tax deductions .
- An EIN must be obtained if employees are hired.
- Any industry-specific business licenses and permits at the state and federal levels are still required.
- LLCs and sole proprietors both have the option to register a DBA name.
As you can see, from taxation to paperwork filing, LLCs and sole proprietorships do have a handful of things in common.
Can You Mix Business Funds And Personal Finances
Sole proprietors don’t have to worry about mixing business and personal accounts from a legal standpoint. In the eyes of the law, they’re regarded as one and the same. However, the practice is still discouraged by most experts.
In an LLC, you must be careful to keep banking records and funds separate from your own personal records and funds. Violating this rule can result in the loss of your limited liability protection.
In The Clinic What Are Kind Of The Questions You Ask To Figure Out Which Way A Business Might Go In Terms Of Forming An Entity
My first question is, How many people are going to own the entity? The reason thats important is because if you just have one person, you dont have to worry about dividing or allocating rights so you have more flexibility in what entity you might choose. Conversely, if you have multiple people, you have to go to the next question, which is, Are they all being treated the same way? Once I know they are not being treated the same way, I have to ask what are those differences and if we need to have a more complicated ownership structure to reflect the different ways the different owners might be treated.
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Does Your Business Name Need To Be Registered For Both
Generally, sole proprietors arent required to register a business name. However, if the business owner decides to operate under another company name, theyll need to register for a DBA or a doing business as name.
LLC names are required to have LLC or limited liability company at the end of their names. In addition, registering your business name gives your additional protection in your state.