What’s the Difference Between an LLC and a Sole Proprietorship?

Understanding the difference between an LLC and a sole proprietorship is critical for entrepreneurs. When first starting a business, most entrepreneurs choose a sole proprietorship because it’s the easiest option. However, as your business grows, you may want more legal and financial protection, which could lead you to establish a limited liability corporation (LLC)

There are significant differences between an LLC and sole proprietorship, each with its own pros and cons. Learn more about the difference between operating as a sole proprietor and an LLC through these frequently asked questions. 


How Does an LLC Protect Me?

An LLC protects your personal finances from liability. If an unhappy customer decides to sue your business, they can only go after the LLC, not you personally. This designation protects your house, car, and family in ways that a sole proprietorship wouldn’t. 


Does It Cost Money to Form an LLC?

Business owners under the LLC umbrella need to register with their states and submit annual fees to stay in operation. You may also need to submit an annual report with your revenue and expenses at the start of the year, depending on where you’ve registered your business. 


How Do You Set Up a Sole Proprietorship? 

It costs nothing to start operating as a sole proprietor. This designation is listed on your tax forms to make sure you pay the correct amount in taxes. You may need certain certifications and licenses within your chosen field before you can start your business, though. 


Can I Deduct Business Expenses as a Sole Proprietor? 

Yes. You do not have to operate as an LLC to deduct expenses like office space, marketing costs, client gifts, and other deductions that could help you when filing your annual taxes. 


Will Operating as a Sole Proprietor Change How I Get Funding? 

Some lenders are wary about investing in companies that operate as sole proprietorships. 

They prefer to invest with registered businesses and owners who have plans for growth. It’s also harder to develop business credit as a sole proprietor, which could limit your ability to secure loans with favorable terms.  


Do I Need Employees to Operate as an LLC?

You don’t need to hire additional staff or contractors if you run an LLC. However, you will need to change your status from sole proprietor if you take on a partner (forming a partnership) or start to grow your business with employees. An LLC is an ideal option if you plan to grow your business.


Will I Have to Pay More Taxes as an LLC?

A sole proprietor is only responsible for their personal income tax; however, someone who operates as an LLC may also have to pay state business taxes and unemployment taxes. These additional steps depend on the state you live in and your business’s size. The costs for completing the tax return for an LLC may be higher and more complicated in your area than a sole proprietorship. 

At the end of the day, the decision is yours as to whether an LLC or sole proprietorship is best for your business. You may want to start as a sole proprietor and eventually evolve into an LLC—which is very common. Do your research and consult with an accounting professional if you still aren’t sure.

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