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One of the questions you need to answer when you start a business is whether to register your business as a sole proprietorship or an LLC. We dive into this question here.
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How you register your business can be critical to your future path. It can also make a big difference on some aspects of running your business such as managing taxes.
That is why it is important to make the right decision when starting your business journey. One of the fundamental questions you will need to answer is whether to register your business as a sole proprietorship or as a limited liability company (LLC).
Your Decision Now Will Have Lasting Effects
The implications of your decision have an effect on how you are viewed by suppliers, customers, and finance providers. For instance, how do sole proprietors get funding?
You will find that the option of forming a sole proprietorship is one of the most widely used business structures. The option of registering as an LLC is also popular.
Choosing between the two will influence potential tax advantages. It will also affect the level of personal legal protection you will enjoy.
Here is a beginner’s guide to what a sole proprietorship entails versus what it means to form an LLC. Once you know the difference between the two, you will be better able to make an informed decision.
What Is a Sole Proprietorship?
In basic terms, a sole proprietorship means you are an individual person running an unincorporated business.
If you want a basic option when forming a legal entity, a sole proprietorship is the default option. This requires the least amount of paperwork and formal arrangements to get your business up and running.
It is important to understand that creating a sole proprietorship is what you do by default. That is, if you don’t choose an alternative business structure in the beginning, you are a sole proprietor by default. You should also understand that you are not creating any form of separation between your personal assets and your business from a legal perspective.
Additionally, you can include some of your personal expenses as part of your business overhead. However, you should also be mindful that this lack of distinction means you will be personally liable for all of the debts and obligations your business creates.
As the name implies, a sole proprietorship means there is only one owner of the business. If you expand or decide to take on a business partner you will have to change the legal structure of the business. Then you could choose either to register your business as a partnership or as an LLC.
Why Would You Choose for Your Business to Be a Sole Proprietorship?
Sole proprietorship is the easiest option when you’re starting a business. If you do a lot of contractual work or earn your money as a freelancer, for instance, it makes a lot of sense to go this route. Then you would file your taxes as a sole proprietorship.
This is the way a lot of business owners start their journey. If you want to keep things simple and you have been running the same sort of business services without expanding much, a sole proprietorship is probably the simplest and most cost-effective option.
It is often the case that you would look at switching to an LLC structure once your profits start to grow. If your business expands you could justify the extra paperwork and expenditure involved in forming a limited liability company.
What Is an LLC?
What is an LLC and what benefits does it offer compared to a sole proprietorship?
A limited liability company (LLC) is a business entity that you register with your state. A key distinction between this option and a sole proprietorship is that the ownership structure can involve one individual or many. There is no limit to how many people can be involved in running the business.
Basically, when you form an LLC you create a clear legal distinction between yourself and the business.
The LLC has its own legal identity. Although you will still have certain legal responsibilities as an owner and shareholder, this business structure often protects your personal assets if the business fails and is unable to pay its debts.
However, single-member LLCs pay taxes in the same manner as if they were a sole proprietorship. That is why it is usually better to choose to become an LLC when the business is bigger or involves more than one owner.
Even if you are single-member LLC you can still choose a more advantageous tax option. This involves registering as an S Corporation or a C Corporation. This gives you a certain amount of tax flexibility that could be more cost-effective. It is always best to discuss your current situation and future plans with a tax professional. A tax professional can guide you through your options and help you choose the best one for your business setup.
Why Would You Choose to Register as an LLC?
There are a number of clear reasons why you might decide to choose to form an LLC instead of a sole proprietorship.
If you have plans to expand the business in the future it makes sense to plan for this by forming an LLC.
It also makes sense to choose the LLC option if you want to enjoy a certain amount of protection for your personal assets and want to limit your legal liability.
Depending on where your business is located, there may be some local, state, or federal tax advantages attached to being an LLC. Again, it would be wise to get some professional guidance as to what sort of business structure might be best for your current and future plans.
Keep in Mind the Key Differences Between a Sole Proprietorship and an LLC
When you run an LLC you need to keep your personal and business finances separate. Also, it is important to note that an LLC offers more tax options.
An LLC could provide your business with a higher degree of credibility and legitimacy. This could make a difference in the opportunities that are available to you to expand your company.
As you can see, choosing between an LLC or a sole proprietorship is an important decision. It is important to get this right at the beginning of your business journey.
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