LLC vs Sole proprietorship

What are LLC and Sole proprietorship?

Limited Liability Company or LLC, a legal entity formed under state statutes, is like a hybrid between a corporation and a sole proprietorship. It gives business owners protection from personal liability and has pass-through income.

Sole proprietorship is the simplest form of unregistered business where the business is not separate from the individual. There is no registration, no structure — just the owner running a business. All the income & losses are treated as the owner's income. Therefore the owner is personally liable for any losses as well.

What are the different types of LLC and Sole proprietorship?

LLC with a single member(owner) is referred to as a single member LLC, whereas if you have multiple members, it is known as multi-member LLC. Without changing the legal entity, an LLC can also elect to be treated as a C-corporation or S-corporation for tax purposes.

There are no types of sole proprietorships. When a person starts performing business activities, it is automatically considered as a sole proprietorship. If you'd like to operate under a different business name, you can register a DBA(Doing Business As). But this won't change the fact that you are a sole proprietor. For example, if John Smith starts a plumbing business under the name "John Smith's plumbing services", he is automatically a sole proprietor. If he registers a DBA, he can operate under any other name like "Water Slasher's plumbing services".

Who are LLC and Sole proprietorship ideal for?

LLC is ideal for small business owners who have been running sole proprietorship and would need liability protection. It is sort of the next stage that business owners move into after starting their business as a sole proprietorship.

Sole proprietorship is ideal for individuals who are just starting out. It's like the very first stage of most entrepreneur's business journey. The main drawback of sole proprietorship is the lack of personal liability protection.

How are LLC and Sole proprietorship treated by IRS?

LLC is governed by state statues. It is only a legal entity, not a new tax entity. By default, LLCs with a single member are treated as a sole proprietorship and multiple members are treated as a partnership. They have a pass-through income, meaning the business income(called distribution) is transferred to the members and are not taxed at the LLC level. Members pay taxes at their individual level. There is no double taxation. Members pay self employment tax (15.3%) on the entire distribution.

Sole proprietorship is treated just like an individual. All the incomes and losses are passed through to the individual. And all the taxes are paid at the individual level. Since IRS doesn't treat sole proprietorship separate from the individual, you're pretty much treated just like an individual. Sole proprietors also pay self employment tax (15.3%) on the income they earn.

How exactly are LLC and Sole proprietorship taxed?

Single member LLC

A single member LLC usually pays 2 types of taxes: payroll tax and franchise tax. Members of the LLC pay income tax at the individual level.

Sole proprietorship

Sole proprietors usually pay 3 types of taxes: Income tax, Self employment tax and Payroll tax(if any employee)

How much do an LLC and a Sole proprietorship cost?

The costs to register and maintain an LLC depend on a lot of factors: state of operation, nature of business, etc.

There is no registration required for a sole proprietorship, but there could be some maintenance costs depending on the number of employees it has.

Single member LLC

LLCs are considered relatively less expensive.

Sole proprietorship

Sole proprietorship is usually considered pretty inexpensive since it is not separate from the individual running it.

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