Sole Proprietorship vs. LLC

Sole proprietorships are popular for self-employed professionals, freelancers, and contract workers, while LLC offers personal liability protection than sole proprietorship.

Author: Brad Nakase, Attorney

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An LLC gives its members limited liability, protecting them from being held personally liable for its financial obligations. A sole proprietorship provides no legal separation between itself and its owner; the sole proprietor owner will receive all its profits and be accountable for all its losses and debts. Overall, a limited liability company offers more protection in terms of personal liability protection than sole proprietorships.

 In this article, our LLC attorney in San Diego will discuss sole Proprietorship vs. LLC as follows:

Is It Better to Be a Sole Proprietor or LLC?

An LLC has distinct advantages in the areas of legal protection and liability. Although sole proprietorship is easier to start and operate, LLC is a separate entity and offers protection in terms of liabilities.

When an entrepreneur begins a new business, it is critical that he or she choose the right business structure for their company. A lot of small business owners prefer two popular entity types due to their flexibility and simplicity: sole proprietorships and limited liability companies (LLCs). The correct option for a small business owner will depend on their particular situation and business needs. However, here are some factors an entrepreneur should consider when deciding on a business structure:

  • Start-up costs
  • Government regulation
  • Liability protection
  • Tax implications

What Is the Difference Between a Sole Proprietorship and an LLC?

A sole proprietorship is an unincorporated business owned and run by one person. An LLC exists separately from its owners—known as members. However, members are not personally responsible for business debts and liabilities. Instead, the LLC is responsible. Sole proprietorships are popular for contact workers, freelancers and other self-employed professionals.

Another key difference between LLCs vs. sole proprietorships is tax flexibility.  Only LLC owners can choose how they want their business to be taxed. With both an LLC and a sole proprietorship, the profit of the business passes through to the owner’s personal tax return.

A sole proprietorship is an unincorporated business that is owned and managed by one individual. This choice is the easiest structure for new entrepreneurs. The business owner is entitled to all the company’s profits. However, unlike an LLC, there is no liability protection for the owner.

A limited liability company is a legal entity that is registered at the state level. An LLC is a separate entity from its owner, who is known as a member. Members of an LLC are not personally liable for business debts or obligations. Rather, the company itself is responsible.

What Is the Importance of Personal Liability Protection?

An LLC is liable for the debts and liabilities incurred by the business—not the owners or managers. Creditors can generally only go after assets that belong to the LLC business, not those personally owned by the LLC’s owners and members. This means that LLC owners, also known as members, are not responsible for paying LLC debts. Personality liability protection means the owners’ assets, such as cars, homes and bank accounts, are safe.

If a business owner runs an LLC, this means that his or her personal assets are protected in the event of debt or a lawsuit. Creditors may generally not go after a business owner’s house, car, or personal bank account.

With a sole proprietorship, there exists no separation between the owner and the company. This means that while an owner is entitled to all of the company’s profits, he or she is also entitled to all of its debts and obligations. It is possible that an owner may be responsible for any of their employees’ liabilities.

What Are the Differences in Taxes for Sole Proprietorships and LLCs?

By default, the IRS taxes it the same as a sole proprietorship. According to the IRS, a single-member limited liability company is a “disregarded entity,” meaning there is no separation between the business and its owner. An individual owner of a single-member LLC that operates a trade or business is subject to the tax on net earnings from self-employment in the same manner as a sole proprietorship.

How to Form An LLC?

To form an LLC in California, go to bizfileOnline.sos.ca.gov, log in, select Register a Business under the Business Entities Tile, Articles of Organization – CA LLC and follow the prompts to complete and submit.

When an entrepreneur decides to form an LLC, he or she will need to file articles of organization, which is sometimes referred to as a certificate of organization, with the state in which the company will operate. Each state will have different requirements.

Usually, an LLC operating agreement is created to record the members’ and managers’ duties and rights.

An entrepreneur should also anticipate filing certain documents with the Secretary of State, as well as paying a filing fee of between $50 to $500. LLCs are required to file annual or frequent reports and pay a filing fee in most states.

A sole proprietorship, meanwhile, can be formed without formal action. However, if a business owner wishes to operate under a different name than their own, he or she will need to file for a DBA.

It may also be necessary to get any required permits or licenses, which will vary according to region, state, and industry.

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