Sole Proprietorship Vs. LLC – What Is Best For Your Business In 2023?
Written by: Tyler Morris
Last Updated by
Rocío Torres: January 20, 2023
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Download NowSole Proprietorship Vs. LLC. A sole proprietorship is when an entrepreneur owns and operates an unincorporated business by himself or herself. Sole proprietors are personally liable for any debts or challenges that the business incurs. They are the easiest business structure to start and operate. The typical businesses that operate as sole proprietors are individuals, and small informal businesses.
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Contents
What is an LLC?
LLC stands for limited liability company. LLCs are granted by individual states. LLCs have few requirements and are attractive because of their liability protection and potential tax savings. This means that any debts and liabilities incurred to the business are separated from the business owners.
Benefits to an LLC:
1. Protects owners from liability:
An LLC protects owners from incurring any personal debt or liability from the business. This includes if a co-owner commits any form of wrongdoing.
2. Limited Requirements:
Avoids unnecessary corporation requirements while simultaneously offering liability protection
3. Tax advantages:
LLCs do not have their own process of federal income tax. Allows LLCs to be taxed as sole proprietorships, partnerships, S corporations (click for more details), or C Corporations (click for more details). Additionally, LLCs are eligible for Pass-Through Taxation, which means owners are able to use business profits (or losses) on personal tax returns.
4. No Shareholder Limits:
Unlike S Corporations, LLCs, do not limit the number of shareholders and owners. This gives the organization flexibility on how they wish to operate.
5. Flexible Profit Distributions:
LLCs distribute profits as they see fit. This means that profits are not necessarily distributed equally or by equity percentage.
6. Flexible Management Structure
LLCs are not required to report to shareholders or a board of directors. This allows LLCs to manage their company how they see fit.
7. Detailed Operating Agreement:
Breaks down ownership responsibilities, equity, and compensation benefits. This is not required in all states, but is highly recommended. This helps protect the rights of all owners in an LLC.
LLC Disadvantages:
1. Expensive Start-Up Costs:
LLCs are more expensive to form and operate than sole proprietorships and corporations.
2. Transfer of Ownership:
Requires all owners to agree on shares being transferred or sold. This can create challenges if there is disagreement among owners.
3. Potential Franchise Tax:
In some states, LLCs are subject to be charged a franchise tax. This allows businesses to operate within that state even if they are chartered in another. It is deemed as a local or a privilege tax. This charge fluctuates between stock value, revenue, and company value.
| States With a Franchise Tax |
|---|
| Alabama, Arkansas, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, New York, North Carolina, Oklahoma, Pennsylvania, Tennessee, Texas, and West Virginia. |
4. High Operating Costs:
LLC employees are considered self-employed and face higher Social Security and Medicare taxes. This means that LLC owners can often be responsible for paying for unemployment compensation
5. Investment Disadvantage:
LLCs are unable to issue stock, which makes it difficult to attract outside investors. Traditional venture capital firms and other outside investors prefer owning stock. While LLCs can issue an ownership structure, compensation packages are widely negotiated, which often creates an investment barrier.
6. Lack of Global Recognition:
LLCs are not recognized on a global scale and can face corporate taxes in other countries.
How to Start an LLC?
Starting an LLC is easy! File for articles of organization with your state’s Secretary of State office. From there, all that remains are a few more steps. Every state has its own unique process, but you can expect the following:
- Choosing a Company Name
- Appointing a Registered Agent
- An individual or organization that accepts all legal paperwork for the business entity.
- Filing a Certificate of Organization
- Filed with the Secretary of State’s Office
- Must Include:
- EIN.
- LLC’s Name and Address.
- General Character of LLC.
- Date of Dissolution (if applicable).
- Name and Address of Agent.
- Name and Address of each Manager.
- Names and Addresses of any eligible document.
- Form an operating agreement
- File with the State
Sole Proprietorship Benefits
1. Fewer registration fees
Since Sole Proprietorships are tied directly to the individual, there are few start-up costs.
2. Easy process to become a sole proprietor:
The vast majority of businesses operate as Sole Proprietorships in the U.S. This allows small businesses and individuals to avoid difficult business requirements, such as forming a board of directors.
3. Straightforward Banking:
Sole proprietorships do not require a business checking account. Owners are able to make business expenses and deposits from their personal bank accounts.
4. Easier business process and tax policies
An Employee Identification Number (EIN) is Not Required. An EIN is an identification number with the IRS that allows wages to be tracked. Sole proprietors only need to register this if they are going to bring on employees. Additionally, there is a Straightforward tax process, as business income and losses are all reported on the sole proprietor’s personal tax return.
Sole Proprietorship Disadvantages:
1. No Liability Protection:
Sole proprietors are not registered as a corporation and are considered self-employed. Sole proprietors are personally liable for any debts or legal challenges.
2. Borrowing Challenges:
Banks typically provide loans and financing to established corporations. This is because they normally have a credit history, making them safer investments. However, sole proprietors are able to seek personal loans for their businesses.
3. Selling the Business:
Sole proprietorship is tied to the individual, meaning that it is impossible for the business to be sold. Furthermore, the business is also unable to be passed down. This means that the only way a sole proprietor can make a profit exiting their business is to sell all individual assets, which is far more complicated than LLCs or corporations.
Why You Would Ever Be A Sole Proprietor
Typical Sole Proprietorships are artists, freelance writers, as well as local mom, and pop shops. These are businesses that bring in typically only a few thousand dollars on an annual basis. Meanwhile, LLCs can range from small businesses all the way to large companies such as Google. While Google’s parent company Alphabet is a publicly-traded corporation, Google itself is an LLC.
Conclusion
Making less than $10,000 from a side hustle? If not, you SHOULD definitely consider opening an LLC. If you expect your business to grow in size or be acquired by a larger corporation, you might want to consider a c-corporation. Click to read or LLC vs. C-corporate article here.
