LLC vs. Sole Proprietorship: How to Make the Right Choice for Your Business

LLC vs. Sole Proprietorship: How to Make the Right Choice for Your Business

LLC vs. Sole Proprietorship: How to Make the Right Choice for Your Business

Advertiser & Editorial Disclosure

The decision to incorporate or not incorporate your business can be a very important choice. For this article let’s address the difference between a limited liability company or LLC vs. the sole proprietorship, to assist you with making the right choice in terms of whether or not to form an LLC. An LLC, or Limited Liability Company, and corporation are not the same thing, although an LLC will provide many of the liability protections typically associated with a corporation.

Limited Liability Company Versus a Sole Proprietorship

One of the key benefits of an 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 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 can protect your personal assets.


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A Sole Proprietorship: What to Consider

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
  • You are only responsible for personal federal, state, local self employment tax and FICA taxes
  • There is no liability protection for you, which puts your personal assets at risk
  • Difficult to obtain funding
  • Tough to build business credit

Advantages of a Sole Proprietorship

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

  • There is no required state paperwork to fill out, unless there’s specific licensing paperwork that’s required on behalf of your industry.
  • There is no required annual state filings to complete, unless there’s specific industry filings required by your industry.
  • All profits/losses are passed through to the owner’s personal tax return and you are only responsible for paying personal federal, state, local and Federal Insurance Contributions Act (FICA) taxes. You are not required to pay any specific business taxes or unemployment taxes.
  • You can still enjoy just about all of the same tax benefits of being self-employed, from turning some of your personal expenses into business expenses (business use of your home or car, for example), utilizing self-employed retirement plans like Simplified Employee Pension Individual Retirement Accounts (SEP IRAs) for higher deductions, writing off regular business expenses such as marketing costs, writing off business travel costs, writing off costs to entertain clients and more.

Disadvantages of a Sole Proprietorship

However, with a Sole Proprietorship, you also have the following drawbacks:

  • There’s no liability protection against commercial debts, lawsuits and other obligations. This means you can be sued personally for commercial activities, putting your personal assets at risk.
  • It’s hard to generate equity financing for a Sole Proprietorship, as many investors choose not to invest in a Sole Proprietorship. This could limit the amount of funds available to grow, develop, and sustain your business.
  • It’s difficult to establish business credit to obtain debt financing for a Sole Proprietorship, as many financial institutions will categorize your request as a “personal loan” rather than a “business loan“, which brings all sorts of caps in terms of approval amount potential. (You can see whether your business has a credit score established and track it for free on
  • You will have a lower amount of market credibility by not operating under a trade name. Now this could be easily resolved by creating a “Doing Business As” Name (DBA) with your state’s department of revenue or the secretary of state, but this will require fees for establishment and ongoing fees to continue to use the DBA name.

Limited Liability Corporation: What to Consider

  • More market credibility
  • Liability protection against lawsuits, commercial debts, keeping your personal assets safe
  • Slightly easier to obtain financing
  • Plenty of paperwork
  • Annual state filings
  • Additional taxes to pay

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 determine if those advantages are worth the additional costs that you will have to pay.

Advantages of Forming an LLC

Forming an LLC separates your personal assets from lawsuits, creditors, etc. 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—like a C-Corporation or an S-Corporation. Although they share some traits in common, and LLC avoids the potential double taxation that occurs with a Corporations. With the LLC, you will have the following benefits:

  • A higher level of market credibility.
  • Liability protection against commercial debts, lawsuits and other obligations. This means, as long as you set up your LLC properly without any co-mingling of personal/commercial assets and properly fund your LLC with working capital, the liability protection should remain in place and you can’t be sued personally for commercial activities.
  • It’s much easier to generate equity and debt financing due to having a separate business entity as well as an established business credit score. This will avoid many potential equity partners and financial institutions from categorizing your request as a personal loan rather than a business loan, which brings all sorts of caps in terms of approval amount potential. It also opens you up to all sorts of commercial debt financing options including easier access to business credit cards, small business loans, leases, factoring, trade credit and more.
  • You can combine the “best” of the incorporation worlds, by electing your single member LLC to be taxed as a Sole Proprietor (which is the standard election), an S-Corporation or a C-Corporation. Electing to be taxed as a sole proprietor just means all profits/losses flow to the owner’s individual tax return like normal. Electing to be taxed as an S-Corporation means the profits/losses flow to the owner’s individual return, but you have the chance to reduce FICA taxes by establishing a “reasonable salary” and receiving the remaining profit amounts as dividends, with only the “reasonable salary” being taxed under FICA.
  • And of course, you will enjoy all of tax benefits of being self-employed.

Disadvantages of Forming an LLC

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

  • State-related paperwork will be required, including any specific industry licensing.
  • Annual state filings (and the associated fees) will be required as well, including any specific industry licensing fees that are required.
  • Besides paying personal federal, state, local and FICA taxes, you might also be required to pay State Business Taxes and Unemployment Taxes.
  • Costs for completing the tax return of an LLC is much higher than that of a sole proprietorship.

Sole Proprietorships vs. LLC: Key Differences

Forming a Sole Proprietorship vs. LLC

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) if you have any employees. 

Forming an LLC is a little more involved, but still a relatively simple process. You’ll need to 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. For legal and tax purposes, you’ll need to choose a registered agent. This could be yourself if you’re a single-member LLC, or one of your business partners if there are multiple members of the LLC. Keep in mind that the IRS considers single-member LLCs as sole proprietors when it comes to taxation.

You’ll then need to file a certificate of formation (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. 

Funding a Sole Proprietorship vs LLC

Whatever type of legal entity you choose to file, 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. If you choose to register your business as a separate entity, do so as soon as possible, and set up a business bank account. Having your business as a separate legal entity and separating your personal income and business income can provide you with legal protection and keep your personal assets safe, depending on how you do it. What’s more, there are a number of lenders that will not approve a business loan application if you don’t have a business bank account.

Getting a startup loan can be difficult for a new business, but there are other funding opportunities available. You can go the crowdfunding route, which is becoming more popular. You can offer donors a gift for their contribution, make them shareholders, or just rely on the goodness of their heart. 

There are also a number of non-profit lenders offering microloans for new businesses. These are structured a little differently than regular financing, so be sure to research your options before moving forward. Some may have tax advantages or more in terms of asset protection over another, so be sure to advise an accountant before moving forward. And, some charge very low or even no interest.

Taxes for a Sole Proprietorship vs. LLC

If you have a sole proprietorship or LLC, there will be changes in your taxes. The most important thing when you start out is to separate your personal and business finances and get your documents in order and on hand. This includes personal tax returns and other income tax documentation, and information on any debts you may carry. 

As a sole proprietor, you may qualify for filing pass-through taxation, which can save you a bit when it comes to pay self-employment tax. Your tax rate can vary depending on your business type, so keeping the proper NAICS code on hand is also vital. 

For a sole proprietor, filing taxes is a bit simpler. Just as your business is a separate legal entity, you’ll want to keep the documentation and finances separate. Having receipts, mileage, 1099s, annual fees, etc.Tracking money coming in and going out will be vital when it comes to taxation.

The current self-employment tax rate is 15.3%. Sole proprietors are responsible for paying the balance on their own. Keep in mind that one-member LLCs can be considered sole proprietors for tax purposes, but for an LLC with multiple members, forming an LLC could cut your tax bill. Only certain types of income qualify for the federal tax rate for C-corporations, meaning you could end up paying less than if you filed as a sole prop or single-member LLC. Check with your accountant to see exactly how much you could save. 

Having the proper documentation regarding your profits and losses, payroll taxes, and any forms regarding real estate owned by your entity will be vital. Be prepared. As an LLC owner, your business will not pay taxes itself, but the profits and losses will be listed on your personal tax return, but having proper division of finances will do you well in the long run.

Personal Liability For a Sole Proprietorship vs. LLC

As a new business, legal protection can be important to your well-being and the longevity of your endeavor. Filing an LLC can protect you personally from business liability. Consider the nature of your business and what is at risk. 

A limited liability company does just that; it limits your liability. As an owner of an LLC, you will not be personally liable for the company’s debts or liability. The same cannot be said for a sole proprietorship. As a sole prop, you would be personally responsible for the debts incurred by your business. This risk may be negligible depending on your situation, but be sure to weigh the pros and cons before moving forward. 

As a rule of thumb, you should seek out liability insurance for your business for additional protection and for your peace of mind. 

Managing and Operating a Sole Proprietorship vs. LLC

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. 

Depending on your preference and the type of business you own, working with someone else and sharing the decision-making can be preferable. This takes a bit of the pressure off of you as an individual, but also leaves some of your sanity at risk if your business partner doesn’t always see eye-to-eye. 

Is an LLC Always the Best Choice?

Life is all about making choices and choosing to form an LLC 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 and taxes 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 break the protective veil. This could be your lack of providing funding to your business, this could be your co-mingling of personal/business affairs, or more.

In addition, some states don’t look too favorably on sole member LLCs, as often 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? So it gets tricky, make sure to sit down with your trusted CPA and business attorney to map out the right route for your business.

Which is Better: a Sole Proprietorship or LLC?

As with so many questions like this, the answer is: it depends. While obtaining funding or financing is equally difficult for both, the protections you can enjoy with an LLC can’t be understated. The additional fees, paperwork, and taxes are paid back in protection for your personal assets, something a sole prop can’t lay claim to.

The Last Word

How you run your business is important. How you incorporate or don’t incorporate it is a vital part of how things will go. Where a sole proprietorship offers freedom and autonomy, an LLC offers significant protection and benefits that are worth considering. 

Keep in mind your business goals and where you want to go. Don’t be scared of asking for advice or help from seasoned professionals.

This article was originally written on December 3, 2019 and updated on May 10, 2021.

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John Tucker

John Tucker has over ten years of professional experience in Commercial Finance and Business Development. Tucker is also an M.B.A. graduate and holder of three bachelor's degrees in Accounting, Business Management, and Journalism. To connect with John Tucker, feel free to send him a connection invite via LinkedIn at:

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17 responses to “LLC vs. Sole Proprietorship: How to Make the Right Choice for Your Business

  1. This has been very helpful in understanding their differences. However, I am still undecided. I am
    staring an online business for toddler clothes. The clothes are exclusively made for me. I am a full time stay at home wife/mom and I am not employed in any way. I want to maximize all the tax benefits for my husband and I but I also want to protect our personal assets on any lawsuits possible in this line of business. I am not getting a loan as of now to finance my business. Everything is from our bank account.

  2. There is a spelling error. “You can combine the “best” of the incorporation worlds, by electing your single memeber LLC to be taxed as a Sole Proprietor (which is the standard election), an S-Corporation or a C-Corporation. “

  3. great article!!
    To the point and answered many questions that have been weighing on me lately. working on starting a plumbing company. just a one man show. And i am now going to start a sole proprietorship (with liability insurance of course) and change to an LLC once more established. thank you for the info very much appreciated.

  4. Thanks John! Going into the trucking business for myself but, I’ll be leasing a tractor through my current employer. I’m leaning towards a sole proprietorships with a focus on obtaining liability insurance. The taxes scare me a bit but I think I can handle it.
    Love your article, man! Well written. Every sentence is meaningful and to the point. I even took notes. Awesome! Thanks again.

  5. Dhanks for the educational information. I want to start a care consultancy business. I am thinking of starting LLC but single-membership. I am living in Connecticut, do I have a referral for a registered agent at a lowest cost since I am starting. Thanks

  6. Thank you for this great article, John! I am considering buying a small business, and your article will help me make some important decisions.

  7. John,
    This is very helpful information for me to know as a small business person.
    It is outlined in clear, easily understood terms. It helps me decide what choice
    is right for me at this time. Thank you!

  8. Hey John,
    Thanks for this great article! Clear and succinct, straight-talking info.

    I was in the same boat couple of years back. I went my first few years in business as a sole proprietor. Then switched to an LLC once I was sure I was going to stick with it.


    1. Between the article and your comment, I now know for sure which route is best for me too. Thanks so much to both of you! My own personal plan was to start with a sole proprietor and by the end of the 2nd year, reevaluate and switch to the LLC. I wasn’t confident if that was an abnormal business move to make or if I was able to legally do so. Thanks again!

  9. I first went to the website for my answers. Seems like double-talk. I found this site. How refreshing to read and actually understand.