Llc Vs Sole Proprietorship: Legal Protection
In a sole proprietorship, theres no legal separation between the business and the owner. The owner is personally responsible for the businesss debts. If the business goes bankrupt, the sole proprietor has to file for personal bankruptcy, and both personal and business debts will be included in the bankruptcy proceedings. In addition, someone who sues a sole proprietorship can name the owner personally in the lawsuit and come after their personal assets.
One of the best ways to protect your personal assets is to form an LLC. Since an LLC is a legally separate entity from the owner, the owner isnt personally liable for the businesss obligations. If the business fails, the owners can file for business bankruptcy, and they dont have to pay business creditors out of their own pockets. And with some exceptions, someone who sues an LLC cant personally sue the owners. Of course, owners in an LLC can be held personally liable for fraud, negligence, or personally guaranteed debts. Theres no business structure that offers absolute protection for owners for liabilities connected to the business.
Overwhelmed By The Paperwork
There are many helpful online services that will aid you in the process of forming your business. Not only do they do most of the work for you, they provide step-by-step instructions, filing expertise, customer service and personalized legal protection. On top of everything else, they save time and almost always save you money!
S Corp Vs Llc Vs Sole Proprietorship
Knowing the differences between Scorp vs. LLC vs. sole proprietorship can be helpful if you are considering one of these types of legal structures. There are many different ways to legally register your business. Some of the most common business structures include S corporations, limited liability companies , and sole proprietorships.
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Llc Vs Sole Proprietorship: How To Choose
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Choosing a business entity structure for your company is one of the most importantbut potentially most confusingdecisions youll make as a small business owner. Unless youre a lawyer or tax expert, the differences between each type of business entity can be hard to understand in real-life terms. However, your choice of business entity does have real-world impact, such as how much you pay in taxes, how much time you have to spend on paperwork, and what happens if someone sues your company.
New business owners are often confused about the difference between a limited liability company and sole proprietorship. In this guide, well look closely at LLCs vs. sole proprietorships, and explain exactly how they differ in terms of formation, taxes, legal protection, and more.
What To Know About Starting A Sole Proprietorship
First, what is a sole proprietorship?
Its a business classification. Its mostly used by freelancers who are doing business under their own name. Meaning if you are a painter and you get contracted to paint a mural on an office wall and charge then $1000 for it, youve just done business as a sole proprietor.
The single biggest thing you need to know about being a sole proprietor is that there is no legal distinction between your business finances and your personal finances.
So, when it comes to taxable income, or when it comes to business risk, your personal bank accounts, investments, or property holdings are all on the table.
Any debt incurred by the business is also totally on you to repay as an individual.
Thats why sole is right there in the name. The buck literally stops with you! You cant have any co owners with a sole proprietorship.
The very cool thing about a sole prop is that it doesnt require any formal paperwork to get started. So, if you are doing business as yourself, under your legal name you are already operating as a sole proprietor.
If you want to do business under another name- say you sell cookies and youd like to sell them under the name Sweet Delight you CAN do that as a sole prop. Youd just need to file paperwork with your state that you are Doing Business As Sweet Delight.
Depending on your state this might be free or some with a small fee.
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What To Consider When Deciding Between Forming A Sole Proprietorship Or Llc
Q: With starting a home-based vegan foods business, is it better to set up as sole proprietor or LLC?
A: I considered this question a few months ago when I started my own law firm. Sole proprietorship is so simple and inexpensive and thus, so appealing. But after researching the issue, I chose the LLC instead. While my law firm might not be as tasty a venture as your vegan foods business, the issues we face in choosing our business entity are the same.
Heres what you should consider:
Tax Flexibility Of An Llc
The Internal Revenue Service does not view an LLC as a separate vehicle for tax purposes, which allows for greater flexibility. Members can choose how they are taxed. They can be treated as a sole proprietorship, a partnership, or a corporation. The most common tax option of an LLC is taxation similar to a sole proprietorship. A member has to pay taxes themselves on the profits of the LLC as opposed to the LLC paying the taxes. The profits and losses of an LLC are passed through the business to the owner. The owner then has to report the profits or losses on their own personal tax returns. The LLC itself does not pay any corporate tax. This method avoids double taxation, which is a drawback of corporations.
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DISCLAIMER: These guides are for informational purposes only and do not constitute professional legal or tax advice. Please consult independent legal advice and your own tax advisors for information specific to your country and circumstances. Shopify is not liable to you in any way for your use or reliance on these guides.
Business Taxes: Llc Vs Sole Proprietorship
New business owners often question whether it would better to be taxed as a sole proprietorship or a limited liability company .
Sole proprietorships and single-member LLCs are taxed in the same way by the IRS. The income from either type of business structure passes through to the owner’s tax return.
The most important question isdo you need the personal liability protection of an LLC?
Keep reading below for more details on how these business structures are taxed or visit our guide on how to choose between an LLC vs sole proprietorship.
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Pros And Cons Of Limited Liability Corporations
With the limited liability characteristics of a corporation and the convenience of a flow-through income taxation , this option is suitable for multiple ownership circumstances.
|The Pros||The Cons|
You have the flexibility of being taxed as a sole proprietor, partnership, S corporation or C corporation.
As an LLC member, you cannot pay yourself wages.
Less paperwork and lower filing costs
High renewal fees or publication requirements can be pricey, depending on your state.
You can form an LLC with as little as one person, but you can also have an unlimited number of members.
Many states have a franchise or capital values tax on LLCs, ranging from a flat fee to an amount based on the companys revenue
Flow-through income taxation, keeping things simple
Investors may be more likely to put their money into a corporation, making it harder to raise financial capital
Members are protected from some liability if the company runs into legal issues or debts.
Unless you are running the LLC alone, the ownership of the business is spread across its members
Members can receive revenues that are larger than their individual ownership percentage.
When To Use A Sole Proprietorship
Sole proprietorships do offer small advantages and benefits in certain circumstances.
Example: A sole proprietorship can be a good way to start out if you are doing business on a small scale or want to try out a low-risk venture to see how successful it will be.
Sole proprietorships are best for small businesses with the following characteristics:
- They MUST be low-profit and low-risk .
- They have a smaller customer base often friends, family, and neighbors.
- They sometimes start as hobbies like photography, blogging, or video streaming.
Sole Proprietorship Advantages and Disadvantages
The only advantage to starting a sole proprietorship vs. an LLC is having to spend no money or energy up front to form a business. This advantage may seem attractive, but it can be costly in the long run.
- No Personal Liability Protection. Your personal assets are at risk in the event your business is sued or if it defaults on a debt.
- No Tax Benefits. Sole proprietors pay taxes on their profits and also pay full FICA taxes . When your business becomes profitable, taxes will be expensive.
- Limited Growth Potential. When a business becomes more profitable, risk increases. When risk and profit increase, so does the need for a legal formal business structure.
- Less Credibility and Branding Opportunities. A sole proprietor must invoice, receive payment, open a bank account, and market with their surname unless their state allows them to register and maintain a doing business as name.
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What Is An Limited Liability Company What Is A Llc Partnership
The limited liability company, or LLC, is the newest type of business form in the United States. The LLC is a unique hybrid: a cross between a partnership and corporation. LLCs have become very popular because they provide the flexibility, informality and tax attributes of a partnership or sole proprietorship, and the limited liability of a corporation.
To form an LLC, one or more people must file articles of organization with their stateâs business filing office. Although not required by all states, it is highly desirable to adopt a written LLC operating agreement laying out how the LLC will be governed. If you donât prepare an operating agreement, the default provisions of your stateâs LLC laws will apply. Operating an LLC is simpler than when you form a corporation. It is not necessary to have officers and directors, board or shareholder meetings, or the other administrative burdens that come with having a corporation.
LLCs are a clear favorite over partnerships because they offer the same tax benefits but also provide limited liability. They are also a serious alternative to corporations, because they are simpler but offer the same limited liability as corporations and have some tax advantages.
When To Use An Llc
LLCs offer taxation benefits, increased credibility, and most importantly, personal liability protection.
LLCs are recommended for businesses with the following characteristics:
- Larger customer base
- Potential for immediate and sustainable profit
- Increased risk of liability or loss
- Would benefit from unique tax options
Advantages of LLCs
- Personal Liability Protection. LLCs provide personal liability protection. This means your personal assets are protected in the event your business is sued or if it defaults on a debt.
- Tax Benefits. LLCs and have options to customize their tax structure. This allows businesses to use the best tax strategy for their circumstances.
- Growth Potential. LLCs can grow in profit and risk because they provide personal liability protection and tax benefits.
- Credibility and Consumer Trust. LLCs generally earn more trust from both banks and consumers than do informal business structures like sole proprietorships. This can impact a business’s ability to take out loans and can affect marketability.
Ready to Form Your LLC?
Our free guide walks you through the process of LLC formation in all fifty states. In just five easy steps, you can be on your way to owning your own business.
You can also use an LLC formation service to register your LLC for you.
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Llc Vs Sole Proprietorship: Which Should You Choose
Many business owners, particularly freelancers or consultants, start out as sole proprietors because its easy. Minimal paperwork is required at the outset, and theres no big outlay of cost, which is attractive for new entrepreneurs, particularly those testing a business idea. Taxes are also simple for sole proprietors, since a separate business tax return need not be filed.
The rubber hits the road as your business starts growing. A sole proprietorship structure offers no legal protection for your personal assets, so you could end up personally bankrupt if your business doesnt succeed as planned, or faces an unexpected challenge. LLC owners, on the other hand, arent personally liable for business debts, so you get more protection in the event of a business bankruptcy or business lawsuit.
On top of this, LLCs offer tax flexibility. Most LLC owners stick with pass-through taxation, which is how sole proprietors are taxed. However, you can elect corporate tax status for your LLC if doing so will save you more money. All 50 states recognize the LLC structure to encourage small business growth. The best business structure for you will depend on many factors, and its best to consult a business lawyer before making this important decision. However, due to the combination of liability protection and tax flexibility, an LLC is often a great fit for a small business owner.
What Are The Pros And Cons Of Sole Proprietorship Vs Llc
There are many pros and cons of sole proprietorship vs. LLC. But before choosing which type of business to form, you should know what each one is.
An LLC, or limited liability company, operates as a hybrid of the partnership and corporate business structures, particularly due to the limited liability protection it offers and pass-through taxation benefits. The LLC is a separate and distinct entity from its owners. It can operate as either a manager-managed or member-managed LLC. This means the members of the LLC will manage the business. However, the members might choose to hire a manager to oversee the business operations.
A sole proprietorship is the simplest type of business to create. It involves only one member who creates the business and reports all profits and losses on his or her own personal income tax return. Generally, a sole proprietorship doesnt have any employees. There isnt any formal action needed to form your sole proprietorship. For example, someone who offers resume review services is considered a sole proprietor.
While there are advantages to both types of business structures, some businesses would be better off creating one type of business over the other, depending on the number of owners, objectives, and overall goals for the business.
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The Pros And Cons Of An Llc
A limited liability company is an independent legal entity. It requires a bit more paperwork and costs more to set up, but it provides significant advantages over a sole proprietorship.
An LLC provides some liability protection. As an LLC owner or member, you cant be held liable for the companys debts beyond the extent of your shareholding. This is to say, you can lose what you had invested in the company, but no one will come after your personal assets.
An LLC offers pass-through taxation. However, when it comes to raising money for the business, investors might be reluctant to invest. Investors prefer putting money into corporations.
Unlike a sole proprietor, an LLC owner cant take a wage from the company. And if the LLC has several members, ownership is spread, which means members could have different opinions on how the company should be run.
Pros And Cons Of Corporations
A corporation is a business entity that is legally separate from its owners. It has the right to enter into contracts, take legal action against others, give and receive loans, own assets, hire workers and pay taxes.
One of the most significant things about a corporation is its limited liability. That is, shareholders have the right to participate in the profits through stocks and paid dividends, but are not held personally accountable for the company’s debts or legal issues that may arise.
Remember that famous trial where the woman successfully sued McDonalds for serving their coffee at too high a temperature? Good thing McDonalds was incorporated!
|The Pros||The Cons|
Owners are separate from legal liability so theyre not entirely responsible when faced with legal issues or debt.
The process is time consuming and expensive, lots of paperwork.
Ability to sell stock, which raises the likelihood of acquiring financial capital.
Tons of regulations, which make for very little flexibility.
Well established structure with clearly defined roles, accountabilities and agendas.
Possibility of double taxation .
Employees have the option to buy stock at a fixed-in price, and receive stock benefits.
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What Is A Registered Agent And Where Do I Find One
Many articles of organization require you to designate a registered agent. This is the person who will accept service of process and other official communications on behalf of the LLC. You can act as your own registered agent, but there may be some situations where you shouldn’t. The article, Three Situations When Having a Professional Registered Agent Makes Sense suggests a professional if:
- You Are Not a Resident of the State
- You Dont Have a Permanent, Physical Business Address or Normal Business Hours
- Finally, if You Work From Home or Wish to Guard Your Privacy
Another option for registered agent is an attorney. This has two benefits. They are bound by ethical rules to ensure that proper notification is given when they receive process on behalf of a client. If you choose to have the attorney represent you in the action, she will have ample notice of it to prepare a response.
Designating an attorney as your registered agent does not mean that they will represent you in court. That is up to you. The designated registered agent can also be changed later, if need be.