Sole proprietorship vs. LLC: Which is right for your small business?

Decisions, decisions. When you launch a new business, you get to dream about business ideas and then choose what type of business to start. You will select a business model: how will your business make money? And you also must to decide how to operate your business; in other words, what type of business entity will you choose?

While most businesses operate as sole proprietorship, a formal business structure such as an LLC or corporation offers a number of benefits, including asset protection and access to more small business financing options. 

But it also costs money and takes time to set up a business entity. So you have to decide whether (and when) it will be worth it. 

 Learn more about an LLC vs. a sole prop in this article from Nav’s experts.

Sole proprietorship vs. LLC: Comparison

One of the key differences — and benefits — of a limited liability company (LLC) versus the sole proprietorship is that a member’s liability is limited to the amount of their investment in the LLC. Therefore, a member is generally not personally liable for the debts of the LLC. A sole proprietor would be liable for the debts incurred by the business. This liability, however, is dependent upon following the rules associated with an LLC. If you treat the LLC the way you would a sole proprietorship, you lose the liability protections.

For example, creditors can go after a sole proprietor’s home, car, and other personal property to satisfy debts, while an LLC that is properly maintained can protect the owner’s personal assets.

This article does not offer legal or tax advice. Consult your advisors to choose the right business structure for your business.

What is a Sole Proprietorship?

When a business operates as a sole proprietorship, it simply starts doing business without forming a separate legal entity. This is the most common business structure used by small business owners in the U.S. It is also the most risky. Here are some key takeaways to think about when considering a sole proprietorship:

• No required paperwork apart from industry-specific licenses 
• No annual state filings
• Simplified tax filing
• No liability protection
• Difficult to obtain financing in the business name
• Harder to build business credit

Advantages of a sole proprietorship

When you form a sole proprietorship, you have the following benefits:

Disadvantages of a sole proprietorship

However, with a sole proprietorship, you also have the following drawbacks:

What is an LLC?

An LLC, or limited liability company, is a legal business structure for operating a business. It is popular with many business owners due to the ease of setting it up, the fact that it is often cost effective and easier to maintain than other business structures such as S corps or C corps, and because it can provide asset protection. Here are some key takeaways to consider when forming an LLC:

• More market credibility
• Liability protection in the case of certain lawsuits and commercial debts
• More financing options
• Some paperwork
• Annual state filings
• Tax advantages and disadvantages

The pros & cons of forming an LLC

Choosing to form an LLC brings both advantages and additional costs. It will be up to you to weigh the costs against the benefits, however, for serious business owners, it is often well worth it.

Read Nav’s Complete Guide to Starting an LLC

Advantages of forming an LLC

When you form an LLC, you are creating a business entity separate from yourself. In other words, you are not your LLC and your LLC is not you. With the LLC, you will have the following benefits:

Disadvantages of forming an LLC

With an LLC, you have the following drawbacks as well:

The best LLC formation services

Here’s the good news: forming an LLC doesn’t have to be expensive or time consuming. Business formation services can help you start an LLC in minutes. And many offer free services; you’ll pay state filing fees and any additional services. 

Nav can help you find the right LLC formation service for your business. Visit Nav’s Business Formation Resource Center.

The difference between an LLC and a Sole Proprietorship

Forming a sole proprietorship vs. LLC

Let’s look at the distinctions of creating an LLC vs. a self-employed business. Forming a sole proprietorship can be as simple as getting to work. Depending on what kind of work you do, you may have to obtain licenses, permits, zoning clearances, or other permissions from your local government. If you so desire, you can form a legal entity and file an assumed business name, and to make tax season more bearable, obtain an EIN (employer identification number). 

You may want or need to file a fictitious business name (doing business as or DBA) with your state, and get an EIN (employer identification number) from the IRS for tax filing purposes. 

Forming an LLC is a little more involved, but still a relatively simple process. You’ll need to choose a legal name your LLC, and be sure to check your proposed name before going to file; you’ll want to be sure you’re choosing a name unique to your business and and check with an attorney before using a name others have protected with a trademark. You’ll also need to choose a registered agent. This could be yourself if you’re a single-member LLC, or one of your business partners in the case of a multi-member LLC. 

You’ll then need to file articles of organization (the specific name of this document can vary depending on your locale) and create an operating agreement, as well as paying a filing fee. Having a business plan in place can make aspects of this step much simpler as you form an LLC. In some states, you’ll be required to obtain your EIN for tax purposes. 

Regardless of whether you decide to form an LLC, you should make sure you have the proper business insurance for additional protection and for your peace of mind. 

Financing a sole proprietorship vs. LLC

Whatever type of entity you decide to operate under, funding will likely be a hot topic and a challenge. Experienced small business owners will likely suggest you keep your full-time job while you get your business off the ground; this personal income can be a steady stream of capital as you get your operation moving. 

Some lenders and financing companies will only extend financing to LLCs or corporations.

And if you want to establish business credit, a business entity is helpful. While you can build business credit for a sole prop, there’s no legal separation between you and your business. Your funding options will be more limited, and that means you can’t much (if any) financing that is solely in the name of the business.

An LLC structure (or corporation) will make the process of building strong business credit more straightforward and effective.Whether you go the sole prop or business entity route, it can be smart to get a business bank account and a business credit card if possible. Many lenders require business bank statements for business financing.

Which pays less taxes, sole proprietorship or LLC?

The tax differences between sole proprietorships and LLCs are significant and can have a major impact on a business’s bottom line. While both entities can pass business income through to personal tax returns, there is a big difference in their flexibility when it comes to tax optimization opportunities.

Sole proprietors face the most straightforward tax situation. They report all business income and expenses on IRS Form Schedule C, which is filed with their personal tax return (Form 1040). The entire net profit from the business passes through to their personal tax return and is subject to self-employment tax at a rate of 15.3%. Many sole proprietors can file their own tax returns with the help of accounting software, which can save money.  

LLCs offer much greater flexibility in how they can be taxed. By default, a single-member LLC is treated as a sole proprietorship for tax purposes. However, the LLC can elect to be taxed as an S-Corporation or C-Corporation instead. This flexibility can create significant tax planning opportunities. For example, an LLC taxed as an S-Corporation can pay its owner a reasonable salary subject to self-employment tax (Social Security and Medicare), while taking additional profits as distributions that avoid this 15.3% tax burden. Distributions are still subject to income taxes, but not payroll taxes. 

Both sole proprietorships and LLCs may qualify for the 20% Qualified Business Income (QBI) deduction under Section 199A of the tax code. This valuable deduction is subject to certain limitations, including income thresholds ($197,300 single/$394,600 married for 2025) and restrictions for specific service businesses. The amount of the deduction may also depend on factors like W-2 wages paid and business property owned.

The tax decision between these entities shouldn’t be made in isolation. 

While an LLC’s tax flexibility can offer advantages, it may come with higher accounting and tax preparation costs. 

Business owners should consider their expected profit levels, plans for reinvestment versus distribution, and potential future sale or succession plans when choosing between the two structures. 

It’s always a good idea to consult a qualified tax professional before making this kind of decision.

Is a single-member LLC the same as a sole proprietorship?

Single-member LLCs are automatically treated as sole proprietors for tax purposes, but may elect to be taxed as an S Corporation or C Corporation. This may provide tax savings but will also carry additional requirements. Check with your tax professional to choose the right filing status for your business.

Don’t forget about self-employment tax! The current self-employment tax rate is 15.3%. Normally this is split between the employer and the employee, but when you are the employer you pay the full amount yourself. (There may be ways to reduce self employment tax for LLCs that elect to be taxed as an S Corp.)

Whichever method you choose, keeping good documentation and staying on top of bookkeeping is essential. Keep good records of both income and expenses and work with an experienced bookkeeper or accountant, at least to set things up properly even if you decide to do your own bookkeeping or taxes.

Personal liability protection

Many business owners opt for LLCs because there is no personal liability and have better protections in place for their assets. However, the personal liability protection is not always absolute, so here are things you can do to stay protected:

• Get LLC Insurance
• Establish business credit without a personal guarantee
• Keep business finances and personal finances separate

Sole proprietorships are known for their lack of legal protection, but people who are worried about liability can take the necessary steps to stay protected. Because of the lack of personal protection, the best way to protect yourself is to convert your business into a single-member LLC.

When should a sole proprietor become an LLC?

The decision is ultimately yours. But keep in mind that as a new business, legal protection can be important to your well-being and the longevity of your endeavor. Forming an LLC early on can help protect you personally from business liability. It can also make your business appear more stable to lenders and vendors, as well as customers and business partners. In that sense, it can be an investment in your success. 

Running a sole prop is as simple as getting to work and tracking your income and keeping it separate. You are the owner and the business, so all decisions are yours to make. That makes it easy to get started, but as your business grows you take on more risk.

Is an LLC always the best choice?

Life is all about making choices and choosing to be an LLC owner can be a very important one. Asset protection consultants routinely market to business owners stating that an LLC is “always a good idea,” but I do not believe this to be true. Some entities are actually better suited for a sole proprietorship as the additional costs of an LLC do not provide any significant benefits over operating as a sole proprietor.

Also, understand that with the concept of an LLC providing “liability protection against commercial acts of your business,” a savvy attorney is going to try to find any loophole he can in your current setup to “pierce the corporate veil” and go after personal assets. 

In addition, some courts may not look favorably upon sole member LLCs, and the question comes up in legal proceedings as to whose interests are you being protected against if technically, you are the only member of the LLC.

When to choose a sole proprietorship

A sole proprietorship often makes the most sense for individuals just starting their entrepreneurial journey and running businesses with minimal risk exposure. 

Freelancers, independent contractors, and hobbyists who are testing the waters of business ownership may benefit from this straightforward business structure. The simplicity and low startup costs make it particularly appealing for those who want to focus on developing their business rather than managing administrative complexities.

This business structure works especially well for service-based professionals who work independently, such as graphic designers, writers, consultants, or virtual assistants. These professionals typically have minimal overhead costs, limited liability exposure, and straightforward business operations. 

A freelance graphic designer, for instance, may operate as a sole proprietorship while building a client base and establishing their business presence and later transition to an LLC if their business grows or risk exposure increases.

Sole proprietorships may also suit small-scale retail operations or local service providers in their early stages. This might include someone selling handcrafted items online, for example.

The key consideration should be the level of personal risk involved. If potential liabilities are low and personal asset protection isn’t a pressing concern, a sole proprietorship may be an ideal starting point.

However, business owners should regularly reassess their choice of business structure as their operation grows. What works well for a startup freelancer may become less suitable as the business takes on employees, accumulates more assets, visits customer or client properties,or faces increased liability risks. The goal should be to start simple with a sole proprietorship when appropriate, while remaining open to evolving the business structure as needs change.

When to choose an LLC

When you think about choosing an LLC over a sole proprietorship, think about liability risks. These aren’t always obvious.

For example, perhaps you sell baked goods at a farmer’s market. That seems like a low-risk business. But what if an ingredient is not properly labeled, and a customer has a severe allergic reaction? Or what if you are driving to the farmer’s market and are in an accident while transporting your goods? Without a proper business structure (and insurance), you could be personally liable. 

E-commerce businesses are another example of when an LLC makes sense. Consider an online store selling consumer products. You face a number of possible risks:

• Intellectual property infringement
• Product liability risks
• Data breach that reveals customer information
• Supplier disputes

An LLC can offer vital protection for the owner’s personal assets while creating a more professional business identity that can help secure vendor relationships and financing opportunities.

The LLC structure proves especially valuable for businesses operating in higher-risk industries or those requiring significant capital investment. 

This includes real estate investors, construction companies, retail establishments, and professional service firms. These businesses often need to sign contracts, lease commercial space, hire employees, or take on debt – activities that can benefit from the legal protection and credibility an LLC provides.

Partnership situations also typically warrant LLC formation. When multiple individuals invest time and resources into a business venture, the LLC’s operating agreement can clearly define ownership percentages, profit distribution, and management responsibilities. If you wind up in a dispute with your business partners, you’ll be thankful for that documentation. 

Let’s look at some specific industry examples to give you a better idea of how to decide on sole proprietorship vs. LLC.

LLCs vs. sole proprietor for professional services

Whether you’re a lawyer, architect, or accountant, you’ll have to decide how to set up your professional services business. The limited liability protection of an LLC is especially valuable in professional services where legal risks may come up. The flexibility of an LLC allows for multiple members, which can foster collaboration and enable a scalable business structure. 

However, forming and maintaining an LLC involves more administrative tasks and may bring higher costs than a sole proprietorship. A sole proprietorship is simpler to establish and manage, with fewer regulatory requirements and lower initial costs. Yet, the main disadvantage lies in the lack of personal liability protection, exposing the owner’s assets to potential business risks. Additionally, sole proprietorships may face challenges in getting small business loans.

LLCs vs. sole proprietor for health care companies

Choosing between a LLC and a sole proprietorship is a big question for health care companies. Opting for an LLC provides a crucial layer of limited liability protection, which helps shield personal assets from business-related liabilities and potential malpractice claims. This is particularly necessary in the healthcare industry. 

Although a sole proprietorship offers simplicity in establishment and management, the significant drawback of a lack of personal liability protection exposes the owner’s assets to potential legal and malpractice risks. Additionally, it’s often easier for LLCs to get health care loans.

LLCs vs. sole proprietor for software companies

LLCs and sole proprietorships both have advantages and disadvantages for software companies. The software industry is prone to intellectual property disputes, so picking an LLC gives business owners some personal liability protection. 

Although a sole proprietorship has fewer requirements and lower costs to start, you may be able to pick up clients easier if you’re an LLC. An LLC is often viewed as more stable and legitimate than a sole proprietorship.

LLCs vs. sole proprietor for truckers

Trucking companies face significant liability since they’re operating large machinery that can be involved in accidents. Opting for an LLC provides limited liability protection for the owner or owners, which keeps personal assets safer and is crucial in the transportation industry where accidents and unforeseen events can occur. 

Additionally, many trucking companies rely on business financing for truckers, and sole proprietors may find it harder to qualify for certain business financing options. Ultimately, the decision depends on the trucker’s priorities regarding liability protection, collaboration opportunities, administrative ease, and scalability in the trucking industry.

LLCs vs. sole proprietor for home services

In the realm of home services, like running a cleaning or a plumbing company, you’ll need to pick between operating as an LLC or sole proprietor. Since you’re running a business from other people’s homes, this is a critical consideration because accidents or property damage might occur. An LLC offers more personal liability protection in case of accidents. Sole proprietors may also face limitations in accessing financing or forming partnerships.

LLCs vs. sole proprietor for retail

For retail businesses, an LLC provides limited liability protection, which is particularly important in a retail environment with potential customer-related risks. A sole proprietorship simply doesn’t offer as many legal protections for the business owner as an LLC.

Additionally, sole proprietors may face challenges in accessing certain business financing options for retailers.

LLCs vs. sole proprietor for restaurants

In the restaurant industry, it’s important to guard yourself against inherent risks like customer injuries or food-related concerns. Restaurant owners can run into legal problems if their customers get hurt or get sick, and an LLC provides limited liability protection for their personal assets. Sole proprietors may also face limitations in accessing certain business financing options or forming partnerships, so if business financing for restaurants is important to you, that should weigh into your decision.

How management structures differ

As a sole proprietorship, you have complete control of your own business decisions without additional input, permission, or legal documents. Sole proprietorships are known to have a simpler structure of management because there’s only one person at the head of the business. As a sole proprietor you only have to make sure that your business is operating legally and safely, and to create a profit margin to reduce business debts.

LLCs can be more complex in terms of the management structures of your type of business. An LLC can be managed by the LLC members or by a manager that’s specifically appointed. Anyone can find that structure in an LLC operating agreement. Not all states require an operating agreement for an LLC, but most businesses operating under them have one — especially with multiple members. An operating agreement details each member’s profit share, voting rights, and stake in the business. 

Mixing business funds and personal funds

For many businesses, starting off can be quite a task of all the information needed just to get running, leaving other areas vulnerable to mishaps. One mishap entrepreneurs can make is mixing business and personal funds. Typically, this is through storing funds within one account which can create a headache when you file taxes, deter investors looking for the business’s financial discipline, and risk accumulating personal versus business debt.

The best way to start an LLC or sole proprietorship is to get a separate business checking account or an additional account that separates business and personal funds. 

Which is better: LLC or Sole Proprietorship?

As with so many questions like this, the answer is: it depends. While obtaining funding or financing can be challenging for any business, the advantages and protections you can enjoy with an LLC can’t be understated. 

Keep in mind your business goals and what you want to achieve. Don’t be scared to get advice or help from seasoned professionals.

If you’re looking for business financing, including small business loans or business credit cards, Nav can help you check, monitor and manage your business credit scores, and show you financing options based on your business data.

Checklist for forming an LLC or Sole Proprietorship

Steps to form an LLC

1. Choose Your Business Name

• Search your state’s business name database
• Ensure the name isn’t already taken
• Check that it meets state requirements
• Verify trademark availability
• Secure matching domain names/social media handles if possible

2. Choose How to Form Your Business 

• Do it yourself, or
• Use a business formation service, or 
• Hire an attorney

3. Select a Registered Agent

• Choose someone to receive legal documents
• Must have a physical address in the formation state
• Can be yourself, another member, or a registered agent service
• Must be available during business hours

4. File Formation Documents

• Complete Articles of Organization/Certificate of Formation
• Pay state filing fees
• Submit to your state’s Secretary of State
• Wait for approval (processing times vary by state)

5. Create an Operating Agreement

• Define ownership percentages
• Establish management structure
• Set profit distribution rules
• Outline member responsibilities
• Document procedures for changes

6. Obtain an EIN

• Get one for free through the IRS website, or
• Work with your business formation service or attorney

7. Set Up Business Banking

• Open a dedicated business checking account
• Keep personal and business finances separate
• Apply for business credit cards if needed
• Choose payment processing solutions if needed
• Set up accounting systems

8. Comply with Other Requirements

• Obtain necessary business licenses
• Secure required permits

9. Choose Your Tax Treatment

• Default: Single-member LLC taxed as sole proprietorship
• File Form 2553 to elect S-corporation status if desired
• Consider C-corporation election for certain situations
• Consult tax professional about optimal tax treatment
• Make election within time limits (typically 75 days)

10. Set Up Tax Accounts and Compliance

• Register for state tax accounts as required
• Set up sales tax collection if required
• Set up payroll if hiring employees
• Establish payroll tax accounts if needed
• Plan for quarterly estimated tax payments
• Create bookkeeping system 

After formation, you’ll also need to maintain your LLC’s good standing by filing annual reports, paying required fees, and keeping accurate records. If you’re not comfortable doing all these steps yourself, consider working with a business attorney or formation service to make sure you set up your business properly and stay in compliance.

Steps to start a Sole Proprietorship

Starting a sole proprietorship is simpler than forming an LLC, but still requires attention to important details. Here’s a step-by-step guide:

1. Choose your business name

• Check name availability in your state
• File DBA (doing business as) registration if using a trade name
• Register domain names if needed

2. Obtain required licenses

• Check local business licensing requirements
• Apply for industry-specific permits
• Secure professional licenses if needed
• Register with county/city authorities if required
• Obtain home occupation permit if applicable

3. Set up for taxes

• Apply for an EIN (may be optional but often recommended)
• Register for state tax accounts if required
• Set up sales tax collection if needed
• Plan for quarterly estimated tax payments
• Set up bookkeeping to track income and expenses
• Organize receipts and expenses

4. Set up business banking

• Open a separate business checking account (recommended)
• Keep personal and business expenses separate
• Apply for business credit cards if needed
• Choose payment processing solutions if needed

5. Establish business protection

• Purchase business insurance
• Consider general liability coverage
• Add professional liability if needed

Unlike an LLC, a sole proprietorship itself doesn’t require state registration (unless using a DBA) or ongoing compliance filings. 

Making the choice: Sole Proprietorship vs. LLC decision checklist

When evaluating whether to form a sole proprietorship or LLC, business owners should carefully consider these key factors:

Risk assessment

• What is your industry’s liability exposure?
• Do you work with physical products that could cause injury?
• Are you providing professional advice or services?
• How likely are customer lawsuits or disputes?
• What valuable personal assets need protection?

Growth and business plans

• Do you plan to seek outside investment?
• Will you need significant business financing?
• Are you planning to hire employees?
• Will you consider adding business partners later?
• Do you anticipate expanding into new markets or states?

Financial considerations

• Can you afford state filing fees and annual reports?
• What is your budget for legal and accounting support?

Business credibility

• How important is having a formal business structure to clients?
• Will vendors or partners require a formal business entity?
• Do you need to build business credit?
• Is professional image critical in your industry?
• Will customers expect a formal business structure?

The answers to these questions should guide your decision making. If you answer “yes” to many questions under risk assessment, growth plans, or business credibility, an LLC or even incorporation may be the better choice. If most answers trend toward minimal risk and simple operations, a sole proprietorship might suffice.

As always, talk with legal and tax advisors to make a decision based on your business circumstances and goals.

Frequently asked questions