LLC vs Sole Proprietorship: Differences and Which One Fits You

LLC vs sole proprietorship: side-by-side comparison

The table compares the two structures for a business with one owner. The SBA says liability, taxes, and filing requirements can vary by state, so treat the LLC column as a general guide and check your own state.

Which one fits you?

Neither structure is right for every owner. The SBA ties its guidance to the risk of the work, the assets you own, and whether you are still testing the idea. The two lists below start with those tests.

A sole proprietorship can fit in these situations:

• You are the only owner of the business.
• The work is low risk, or you want to test an idea first. The SBA says sole proprietorships “can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.”
• You understand that you can be held personally liable for the debts and obligations of the business.
• A state filing fee and yearly state reports would be hard to justify at this stage.

An LLC can fit in these situations:

• The work carries more risk, or you own assets you want to protect. The SBA says LLCs can be a good choice for “medium- or higher-risk businesses” and “owners with significant personal assets they want protected.”
• You plan to have a co-owner. An LLC can have more than one member, and a sole proprietor owns the business alone.
• You plan to borrow for the business. The SBA says “banks are hesitant to lend to sole proprietorships,” although a lender may still ask an LLC owner for a personal guarantee.
• You want the business to have its own legal existence and its own name on file with the state.

Before you choose an LLC, price it in your own state. The cost table later in this guide shows how much the yearly charges can differ.

You can also change later. The SBA says “you may convert to a different business structure in the future,” and it warns that “there may be restrictions based on your location.” It adds that a change could bring tax consequences. Our guide on how to convert a sole proprietorship to an LLC covers those steps. If timing is your main question, our guide on when you need an LLC works through it.

What LLC liability protection does not cover

A sole proprietor and the business are legally the same. The SBA says “You can be held personally liable for the debts and obligations of the business.” Its comparison table lists the sole proprietorship as “Unlimited personal liability.”

An LLC reduces that risk, but the protection has conditions. Delaware’s LLC law, as one example, says no member is obligated personally for the LLC’s debts “solely by reason of being a member or acting as a manager of the limited liability company.” The word “solely” is important. Being a member does not make you liable, but other facts can.

Small owners should know at least these two limits:

• Personal guarantees. Delaware’s law says a member “may agree to be obligated personally” for the LLC’s debts. A guarantee you sign is that kind of agreement. For SBA loans, the federal rule says “Holders of at least a 20 percent ownership interest generally must guarantee the loan.”
• Your own wrongful acts. Washington’s LLC law says “A member or manager of a limited liability company is personally liable for such person’s own torts.” A tort is a civil wrong that causes harm, and negligence is one type. So an LLC may not protect you from a claim about harm you caused yourself.

Those two examples come from Delaware and Washington. Your state’s LLC law may use different words, so ask a lawyer how it applies to you.

The SBA says an LLC “can protect your personal property from lawsuits. However, that protection has limits.” It adds that “Business insurance can fill in any gaps in coverage.” The SBA lists general liability insurance for “Any business,” so that advice applies to sole proprietors too.

At what income level is an LLC worth it?

The IRS and SBA business structure pages listed at the end of this guide do not set an income level for this choice. The SBA’s guidance uses the risk of the work and your personal assets as its tests.

Higher income alone does not change the default federal tax treatment. A single-member LLC that does not elect corporate treatment is a “disregarded entity,” and its activities go on the owner’s federal return. For an individual owner, that generally means Schedule C, Schedule E, or Schedule F with Form 1040.

The IRS says an individual owner who operates a trade or business pays self-employment tax “in the same manner as a sole proprietorship.” So forming a one-owner LLC does not, by itself, lower your federal income tax or self-employment tax.

Other choices can change that result. An LLC can file Form 8832 to elect treatment as a corporation, and the SBA says “It’s possible for an LLC to be taxed as a C corp, S corp, or a nonprofit.” Those are separate tax decisions. If you see a specific income figure online, ask what it is based on, and talk to a tax professional before you elect.

Employees and state charges matter too. For employment tax and certain excise taxes, the IRS treats a single-member LLC as a separate entity. An LLC with employees needs its own Employer Identification Number (EIN). Some state charges depend on income. California says “If your LLC will make more than $250,000, you will have to pay a fee.”

A one-owner LLC with a foreign owner has extra federal rules. The Form 5472 instructions define a foreign-owned U.S. disregarded entity as “a domestic DE that is wholly owned by a foreign person.” Ask a tax professional about those filings.

What is the biggest disadvantage of an LLC?

In our view, the biggest disadvantage for a small owner is the ongoing cost and paperwork. The IRS and SBA pages do not rank the disadvantages, so that ranking is our judgment. A sole proprietor pays no state fee to form the business. An LLC pays a state fee to form, and it may owe more each year.

The SBA says “In most cases, the total cost to register your business will be less than $300, but fees vary depending on your state and business structure.” Yearly charges also differ by state. The table shows three examples.

An LLC also adds paperwork that a sole proprietor does not have. The SBA says of an operating agreement, “It’s widely recommended to create one to protect yourself and your business, even if your state doesn’t mandate it.” It also says some states may require an LLC to be dissolved and re-formed when a member joins or leaves, unless an agreement is already in place.

A sole proprietor can still have costs. If you use a trade name, you may need to register a DBA. Travis County, Texas, for example, lists a filing fee of “$23.00 for business name and one owner.” Either structure may also need licenses and permits, and the SBA says those “will depend on your business activities and business location.”

Which address goes on the public record?

A sole proprietor files nothing to form the business, so no formation record shows an address. A DBA filing can change that. In Texas, an assumed name certificate for an individual must state “the individual’s full name and residence address.” Other states use their own forms and wording. Our guide to a sole proprietor’s business address explains where that address can become public.

An LLC filing can put more addresses on the record. The SBA says articles of organization include “the company name, address, member names, and the registered agent.” What goes in them varies by state and business structure, the SBA says. California’s Form LLC-12 instructions say “the name and the physical street address of the agent for service of process is a public record, open to all (as are all the addresses of the LLC provided in filings).”

Texas says its Public Information Report “lists the names and addresses of persons who are officers/directors and managers at the time the report is filed.” So an LLC filing can make an address public.

Read each address line on your form before you fill it in, because each line has its own wording. That wording applies to a virtual address or a mail service address, including ours, in the same way it applies to any other address.

Whichever structure you choose, you may want a place to receive general business mail. Our Silicon Valley and Los Angeles pages describe the business addresses save office offers.