LLC vs. Sole Proprietorship

As an entrepreneur, one of the biggest decisions you'll make about starting your own business is whether to act as a sole proprietor or form an LLC. Often businesses have been acting as sole proprietorships for some time before they elect to form an LLC.

We recommend seeking the advice of your tax accountant or attorney if you are unsure which business structure is right for you. Let's take a look at each business structure to give you some idea of where to start. 

llc vs sole proprietorship

What is an LLC?

The term LLC is the commonly used acronym for Limited Liability Company. An LLC is a hybrid business entity that combines many of the best features of corporations with those of partnerships.

Like a corporation, an LLC is a separate legal entity distinct from its owners; thus removing the owners and managers from any personal liability for the company's debts or obligations.

Unlike a traditional, or "C" corporation, an LLC passes its income or losses through to its members. This places the tax impact of the activities of the LLC upon the members and not on the LLC entity.

What is a Sole Proprietorship?

The U.S. Small Business Administration describes a sole proprietorship as follows:

"A sole proprietorship is the simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and you, the owner. You are entitled to all profits and are responsible for all your business’s debts, losses and liabilities."

Basically if you are making money as an entrepreneur or with your side gig, you may already have a sole proprietorship.

Advantages of an LLC

Limited Liability for Members and Managers

The biggest advantage of forming an LLC is that it provides limited liability for its members and managers. This means that during any litigation, the personal assets of the members and managers are protected. 

It is important to remember when operating an LLC that it must be treated as an entity separate from the members. If the members or managers act as if they are the LLC, there exists the possibility that a court will set aside the liability protection and look to the members for individual liability. The LLC should have its own checking account, its own insurance policies and contract in its own name.

Passthrough Taxation

LLCs are taxed as partnerships at the federal level. This means that the owner of the LLC simply reports their share of profits and losses on their individual tax return. 

This is an incredible advantage because it avoids double taxation, when the income of the business is taxed first at the corporate level and then again at the individual level. 

Fixed Annual State Franchise Tax 

Delaware LLC's are required to pay an annual tax of $300 to the state of Delaware. Unlike corporations (whose taxes are based on the number of shares or assumed par value capital), the annual state franchise tax for LLC's is the same for all, without regard to size or number of members.

Advantages of a Sole Proprietorship

Ease of Setup 

The best part about forming a sole proprietorship is that nothing is required of you to do so. In fact, many individuals may actually have a sole proprietorship without even realizing it!

In todays "gig economy", if you're making money off of a side hustle and do not have an LLC set up, you probably have a sole proprietorship. 

Simple Taxes

Taxes for your sole proprietorship are not taxed separately from your personal income. 

Disadvantages of an LLC

Cost of Initial Setup

The initial cost of setup of an LLC varies by state and also by service.

In Delaware, The Incorporators Ltd. can form an LLC on your behalf for as little as $175. We take care of everything and you can have your LLC officially formed with all documents in your inbox within 24 hours!

Yearly Taxes Due to State

As we mentioned above, Delaware LLC's are required to pay an annual tax of $300 to the state of Delaware. Most view this as a small price to pay for the personal liability protection that the LLC affords. 

Disadvantages of a Sole Proprietorship

Personal Liability

When you and your business are legally viewed as one entity, your personal assets are at risk. This means that if someone sues your business, they are actually suing you as an individual.

Difficult to Obtain Funding

It is extremely difficult to obtain funding for your business as a sole proprietor. If you are planning to try to raise capital or get a business loan from a bank, you will usually be required to provide proof that your business has been officially formed as an LLC or corporation.

Generally you'll be asked to provide a Certificate of Good Standing. Luckily, we can help you with that. You can order a Delaware Certificate of Good Standing online here.

When to Form an LLC

If you're unsure if you should form an LLC, talk to your accountant or attorney. Most successful businesses reach an income threshold at which it is beneficial to no longer act as a sole proprietorship. Your accountant or attorney can help you decide when that point is.

If you have any questions or would like to form a Delaware LLC, feel free to contact us or use our easy online order form to form a Delaware LLC today. 

DISCLAIMER: The Incorporators LTD. is a business formation service company only.
All content on this site is for informational purposes only and should not be construed as legal, taxation or financial advice or services.