There are legalities to attend to when starting a small business, whether you’ll be opening a reselling or distributor business or launching an eCommerce store.
Before anything else, you’ll need to decide whether you will be establishing your business as a sole proprietorship or a limited liability company (LLC). Depending on the option you choose, it can affect your liability, obligations towards compliance, and tax reporting.
With that in mind, this article explores the difference between the two business structures to help you understand which legal entity your business should take on.
What Is Sole Proprietorship?
Essentially, the sole proprietorship is a standalone business with a single owner. Registered businesses with a sole proprietor entity are the most affordable type of business a person can operate.
You can run a retailer, set up an online business, or offer products and services automatically, making you the sole proprietor on the spot. All the profits made by the business and various operational decisions are controlled and managed by you alone.
Contractual jobs, such as consultants and personal trainers, are also considered sole proprietorships. This business structure is generally chosen when you’re a starter business or making limited income.
It’s easy to tell the difference between LLC and sole proprietorship. Among the telltale signs is that the owner's name is usually along with the business name, but in some cases, they can also operate under a trade or brand name.
But the foundation lies in the fact that there is a non-existent separation between the owner and the business. This means that for any debt incurred by the business, the owner would shoulder its legal responsibilities.
Advantages Of Sole Proprietorship:
- There is only a single federal income tax return filing since the owner and the business are the same entity. If a second owner joins the single-member LLC, the business will enjoy the same benefit and file a partnership tax return.
- Aside from an industry-specific license, generally, there are no paperwork and permit requirements involved. But depending on your local government, you may have to file zoning permits or licenses to start your business and operate it legally.
- Considering you’re the sole owner in this type of business structure, you have overall control over decisions concerning your business operations, unlike other business structures wherein you’d need to consult other partners or stakeholders.
Disadvantages Of Sole Proprietorship:
- The sole proprietorship business has no liability protection against lawsuits, debts, and other obligations. As mentioned previously, as the sole owner, you’ll be personally liable and responsible for any debts incurred by your business, which can put your assets at risk.
- A business under the sole proprietorship entity uses the owners' social security number. Any incurred credit stays included in the business credit. And so, building business credit and securing funding or capital can be difficult, especially when starting, because of the lack of key requirements for commercial loans.
- There are no tax benefits for sole proprietorships. The taxes are paid off on their profits, social security, and Medicaid taxes. The more your business prospers, the higher the taxes you will need to pay.
What Is An LLC Entity?
LLC stands for limited liability company, a business entity that combines the attributes of a sole proprietorship and a corporation. LLCs have many kinds, and they each have characteristics and parameters.
If you’re the only person in total control of the business, yours would be called a single-member LLC. But an LLC can also have multiple owners running the company. You can create the business entity through document filing in your state. You may consider hiring a seasoned agency like NW Registered Agent to guide you through the entire procedure. This GovDocFilling NW Registered Agent review helps you to understand more about it.
Once the LLC has been registered, the business takes on its own identity separate from the owners. If a company fails or raises debt, creditors cannot legally force you or your associates to make payment. The LLC entity can also protect you from the actions of your employees if the business goes bankrupt.
When it comes to taxation, an LLC with one member pays the same as sole proprietorships. But LLC businesses also have flexibility as they have an alternative to paying taxes as a C or S corporation, which allows them cost-effective means to pay their dues. Some companies take the LLC route to get corporate taxation advantages.
Advantages Of LLCs:
- Unlike the sole proprietorship, which doesn’t separate the owner from the business, LLCs puts a barrier between the two. Legal protection is placed around your assets, making it untouchable for those creditors demanding payment.
- If the business entity is separate from you and you have a good business credit score, it’s easier to get approval for equity and debt financing. There’s no need for personal loans. You can choose from factoring, leases, small business loans, and other alternatives.
- Gaining the trust of consumers and established businesses like banks is easier for LLCs than sole proprietorships. The latter is an informal business structure that can have issues with marketability.
Disadvantages Of LLCs:
- LLCs can generally be more costly as compared to sole proprietorships. Among the expenses you’ll have to prepare when starting your business under this structure is filing costs, which depend on the state you’ll be establishing your business. You’ll also be expected to pay ongoing costs, such as franchise tax and business license renewal fees.
- With an LLC business structure, you may be required to process various paperwork and documents when registering your business, as compared to sole props. This includes reserving or registering your business name, initial and annual reports, business license, articles of organization, operating agreement, and tax forms, among others.
Choosing Between Sole Proprietorship And LLCs
As discussed above, both business structures have their advantages and disadvantages. To help you make an informed decision on which option is better for your business,
Here’s a brief comparison between sole props and LLCs:
- Management Structure: In LLC, the operating agreement states how the operations will run, which is a legal document for all of its members. They may also elect a manager who will take care of the business daily. On the other hand, if you’re opting for sole props, the control over business operations and decisions is solely yours.
- Taxes: Sole proprietorships must report their income and outgoings and be included in personal income tax returns. The business owner may find that tax consequences are the primary reasons one must decide between the two entities. But with an LLC, there’s the choice for businesses to decide on a different income tax treatment.
- Liabilities: Many businesses choose LLCs due to asset protection, and the entity doesn’t come with personal liability. But to ensure you are protected, you can get LLC insurance, don’t include a personal guarantee when establishing business credit, and keep business and personal finances separate. Sole proprietorships don't come with legal protection.
- State Registration: Sole proprietorships only require business name registration and obtaining licenses. You can immediately start your business and keep renewing your license as needed. With LLC, you must file the “Articles of Organization” that states the roles and responsibilities of each owner, obligations, powers, and rights. Moreover, registration rules and fees vary from one state to another.
When starting a business, it’s essential to know which entity it will take on for various reasons, such as taxes, compliances, and liabilities.
However, answering the question of which entity is better still depends on conditions appropriate to your type of business. And at the end of the day, the ideal structure should help you grow a successful business with the balance of protection and flexibility it can give.