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LLC vs Sole Proprietorship
LLC and sole proprietorship are the most suitable options for single-person businesses.
Both have their own perks. Entrepreneurs usually start with sole proprietors and usually “graduate” into an LLC.
Let’s take a close look.
LLC
Sole proprietship
Separate legal entity
Yes
Not separate from individual
Separate tax entity
No
Not separate from individual
Types
Single-member LLC,
Multi-member LLC
Just C-corp
Liability protection
Yes
No
Default tax treatment
Sole proprietorship for single-member, Partnership for multi-member
Sole proprietorship
Double taxation
No
No
Formalities
Relatively less. Easier to maintain
No additional registration required
Ownership
Owned by members
A single person
Organizational structure
One or more members usually govern and execute everything
Managed by a single person. Can have employees
Definition
What Are an LLC And a 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.
A 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.
Types
What Are The Different Types of an LLC And a 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 a 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”.
Ideal For
Who Are an LLC And a 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.
For various businesses
If you are just starting out and don’t expect a lot of risk, you can start with a sole proprietorship with a DBA. Once you start earning, you can form an LLC.
You could start out with sole proprietorship with a DBA. But as soon as you start earning, you may want to form a single member LLC
Choosing LLC and electing your LLC as a corporation would save some money on taxes as compared to the default multi member LLC. Sole proprietorship isn’t highly preferred.
For a high growth SaaS company, C-corporation is usually the better business entity. Only a corporation can issue stock to your employees, contractors or investors. Both LLC and sole proprietorship may not be ideal for high-growth companies.
Tax Treatment
How Are an LLC And a 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.
A 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.
Tax Rates
How Exactly Are an LLC And a 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.
32 – 37%
Top 3 personal income tax rates
21%
Corporate income tax rate on profits
23.8%
Individual income tax on shareholder’s dividends
6.2%
Employer portion for social security tax
1.45%
Employer portion for Medicare tax
6%
Total FUTA tax, including state credit
Sole Proprietorship
Sole proprietors usually pay 3 types of taxes: Income tax, Self employment tax and Payroll tax(if any employee)
32 – 37%
Top 3 personal income tax rates
15.3%
Self-employment tax
1.45%
Employer portion for Medicare tax
6.2%
Employer portion for social security tax
6%
Total FUTA tax, including state credit
Costs
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.
One time
Formation fee for the State
$90
Reserve business name
$75
Annually
Registered agent costs
$100 – $300
State franchise tax
$50 – $800
Quarterly
Income tax
21 – 37%
Payroll tax (employer)
7 – 10%
Service charges
Lawyer
$100 – $500/hour
CPA
$100– $500/hour
Sole Proprietorship
Sole proprietorship is usually considered pretty inexpensive since it is not separate from the individual running it.
One time
Registering DBA (optional)
$0 – $100
Annually
Registered agent costs
$100 – $300
Quarterly
Individual shareholder Income tax
21 – 37%
Payroll tax (employer)
7 – 10%
Service charges
Lawyer
$100 – $500/hour
CPA
$100– $500/hour
FAQ
Frequently Asked Questions
Here are the most commonly asked questions about LLCs and Sole Proprietorship:
Not necessarily. A single member LLC is taxed exactly like a sole proprietorship. However, if the LLC is elected to be treated as a corporation by filing Form 8832, it may end up paying lesser tax than a sole proprietorship.