EA - Sole Proprietor vs LLC - The Pros and Cons of Each

Sole Proprietor vs LLC: The Pros and Cons of Each

One of the most important decisions you can make as a small business owner is choosing the right structure for your new company. Even though the business structure seems like a minor detail, it impacts the taxes that are paid and paperwork that needs to be filed with the IRS. In this article, we are breaking down the differences so you can choose between a sole proprietor, LLC, or another type of business structure.

Types of Business Structures

Selecting the right type of business structure is key for finding the best balance of protection while optimizing available benefits. Here are some of the most common business structures used for small companies and startups:

  • Sole Proprietor: Many business ventures start as a sole proprietorship, which is the most common type of business structure. It means that one person is the sole owner and operator of the company, which is a good solution if you want to manage all of the details of the company. There is not a separate business entity, so it means that all personal income and business expenses are filed on the personal tax return.
  • Limited Liability Company: The nickname for this structure is LLC. It is a flexible structure that gives you the benefits available through both corporations and sole proprietorship. The business is structured as a separate entity, so business and personal liabilities are not mixed. LLC requirements vary in each state, so it is important to work with a professional to ensure the proper formation of this structure.
  • General Partnership: When two or more people are owners in the company, then a partnership agreement can be formed. In this situation, all partners are responsible for the business and hold ownership of the debts and liabilities of the company. The losses and profits are shared equally among partners. Similar to a sole proprietorship, profits are also taxed through personal income.
  • Limited Partnership: The minimum requirements for a limited partnership is that there must be at least one general partner and one limited partner. The general partner is involved in the day-to-day activities of the business, as well as major business decisions. On the other hand, the limited partner has no rights to the business decisions, they only act in the capacity as an investor. The general partner maintains responsibility and liabilities, which means that the limited partners hold ownership without the risk.
  • C Corporation: Commonly referred to as a C- Corp, this business structure is created as a separate entity from the owner. The business is structured as an independent legal entity. The benefit of this separation is the protection against personal liability. Specific tax requirements and regulations need to be met, including extensive reporting and recordkeeping. It is a complicated business structure but sets the business up for future expansion if desired. Double-taxation occurs with this business structure.
  • S Corporation: Commonly known as an S- Corp, this structure passes the profits and losses through the business owner’s personal income, without the cost of corporate tax rates. The corporation has a max limit of 100 shareholders. Strategies can be used to avoid double taxation, with the owners and shareholders being taxed.

Small Business: Choosing Between a Sole Proprietor vs. LLC

In most cases, it makes sense for small businesses to be structured as a sole proprietor or LLC, depending on the needs of your company. You don’t need to read the fine print to know all of the details and differences. Instead, talk to an experienced accountant and business attorney for advice in structuring your company.

Also, know that this business structure is just the starting point. Your accountant can offer recommendations in the future when it is time to grow, depending on the trajectory of your business success. Sometimes businesses need to be restructured to manage taxation and liabilities.

In the next few sections, we will break down the benefits and drawbacks of both sole proprietorships and LLCs. This information will give you a general overview of your options. Then, you can talk to your accountant and/or business attorney with a clear understanding of how the structure will impact your business.

Sole Proprietor: Pros and Cons

There are advantages and disadvantages to structuring your business as a sole proprietor:

  • Pro – Simplicity: As a sole proprietor, you don’t have to go through any paperwork or complicated systems when setting up the company. In the beginning, there is no state paperwork that needs to be filled out and filed. Additionally, you don’t need to worry about annual state filing.
  • Con – Liability: Since the business assets are in your name, you will be held personally liable if anything goes wrong. If your business is in debt, then your personal assets could be at risk. For example, a creditor could go after your car, home, or other personal property of significant value to repay outstanding debts.
  • Pro – Maximizing Business Deductions: Any time you spend money on business expenses, those costs can be written off your personal tax filing as deductions.
  • Con – Restructuring as the Business Grows: Once you reach a threshold of annual earnings, it is usually best to restructure the company to optimize tax payments. Maintaining a sole proprietorship could cost more money, in the long run, depending on how much money you are earning. Talk to an accountant for personal recommendations.
  • Pro – One Tax Filing: As a sole proprietor, there is no need to file a separate tax return for your business. If you have a corporation, then two returns need to be filed (one for your personal taxes and one for your business taxes).
  • Con – Building Busines Credit: Since the business expenses are in your name, it can be difficult to build business credit. A lack of business credit could have an impact on your ability to get financing in the future when needed. As a result, it might be hard to get funding when your business is expanding.
  • Pro – Managing Business Taxes: Since all profits and losses are passed through your personal tax return, you only need to pay federal, state, and local taxes, as well as Federal Insurance Contributions Act (FICA). Some of your personal expenses can be leveraged as business expenses, such as your home or car that is used for business activities.

LLC: Pros and Cons

Does it make sense for you to set up a Limited Liability Company (LLC) for your new business venture? Here are a few pros and cons that should be considered before moving forward with this business structure:

  • Pro – Various Benefits: The main reason why people choose an LLC is to take advantage of the benefits available as a sole proprietor, with the protections that come through a corporate structure.
  • Con – Limited Lifespan: If the business structure changes, then your LLC might be dissolved. For example, if a partner joins or leaves, then it might be necessary to restructure.
  • Pro – Flexibility: This business structure is flexible, making it easy to adjust the structure based on your individual needs.
  • Con – State Requirements: Every state is unique in the way LLCs are managed, so the tax liabilities vary depending on where your business is located. It is important to learn about state requirements before deciding whether an LLC is the right structure for your business. Sometimes industry-specific licensing is needed in addition to the state requirements.
  • Pro – Avoid Double Taxation: Double taxation occurs for most corporations, with taxes required for the business and the individual. An LLC protects you from double taxation.
  • Con – Paperwork: Not only do you have paperwork that needs to be completed for the formation of an LLC, but there are often annual state filings as well.
  • Pro – No Business Debt Liability: LLCs protect small business owners from personal liability for the business debt. If a creditor is demanding payment or your business is facing a lawsuit, it means that your personal assets (such as your home and car) are safe.

Choosing Between Sole Proprietor and LLC

Is it time for you to structure your new business venture? As you are getting started, it is helpful to talk to industry pros to learn more about the most strategic approach for your unique needs. This conversation should cover a variety of details that can impact the success and long-term profitability of your company, including:

  • Tax burden and how to minimize the amount you will be paying each year
  • Cost of setting up and maintaining the business structure
  • Legal liabilities carried by the business, yourself, and partners
  • Flexibility of the business structure and how it meets the needs of your company

Easier Accounting is Here to Help

If you need accounting and bookkeeping assistance for your small business, then our team at Easier Accounting is just a phone call away. We specialize in small business bookkeeping and can help with a variety of business structures, including a sole proprietor, LLC, and corporations. We take care of the financial details so that you can keep your focus on other business responsibilities to help your company grow. Call to learn more about how we can assist: (888) 620-0770.

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