Are you ready to start your e-commerce business? Store opening checklist There’s probably a ton of fun stuff going on, like finalizing your logo and branding, sourcing the perfect products, building a marketing plan, etc. And while starting your own business is certainly exciting, it often comes with some not-so-exciting decisions to make, like choosing a business structure.
One of these decisions is whether to set up as a sole proprietorship or an LLC, a decision that can have a significant impact on your compliance obligations, how you pay taxes, and your personal liability.
This guide compares the differences between sole proprietorships and LLCs to help you decide which business structure is right for you as a new business owner.
What is a sole proprietorship?
a Sole proprietorship The most basic IndustryIt is an unincorporated business owned by an individual, and there is no legal separation between the business entity and the owner. With a sole proprietorship, the business and its income are managed solely by the individual. The profits of the business are reflected on the individual’s tax return and are taxed at the individual’s tax rate.
Setting up and running a sole proprietorship is a relatively easy process, making it a popular choice among self-employed individuals (e.g. freelancers), small business start-ups, and low-risk businesses. Print on Demand Corporation. Unless you take the steps to legally set up your business, you will be a sole proprietor by default. There are no formal registrations or filing procedures required to start this type of business.
Read the detailed guide The advantages and disadvantages of running a sole proprietorship You can learn more.
Pro Tip: Laws regarding sole proprietorships vary by state and the nature of your business. We always recommend checking with your local jurisdiction to determine the requirements for setting up a sole proprietorship and any required tax filings, licenses, and permits.
What is an LLC?
Ann Limited liability companyor a limited liability company, Types of business An LLC can be owned by a single individual or legal entity, or jointly by multiple partners, called members. CorporationHowever, taxation is the same as for sole proprietors.
With an LLC, business profits pass through to each member and taxes are paid at their personal tax rates. The business entity and owners are legally separate. This protects the owners (you and any partners) from personal liability for business debts and legal claims, although the extent of protection varies by state. LLCs can also form their own legal entities. Business CreditLLCs are popular with consultants, e-commerce businesses, and others because of their flexibility and liability protection.
There are many different types LLCEach has different parameters. Single Member Limited liability companyA corporation, the closest form to a sole proprietorship, is made up of one owner who controls 100% of the business.
LLCs must be formed in the state in which they operate and usually be chartered by the federal government. Employer Identification Number Complete paperwork such as your EIN and Certificate of Incorporation Organization rulesDocumentation requirements may vary by state.
Click here for details Benefits of Forming an LLC.
What is the difference between an LLC and a sole proprietorship?
| Limited liability company | Sole proprietorship | |
|---|---|---|
| responsibility | Increases personal liability protection for owners. | There is no personal liability protection for business debts. |
| tax | Tax flexibility. Choose an S corporation or a C corporation. | Pass-through taxation. Self-employment tax applies. |
| cost | Higher upfront costs. Registration and permits required. | The initial costs are low and it’s usually free to get started. |
| Funding | It makes it easier to raise funds through a variety of means. | Financing options are limited – often only a personal loan. |
| Management and Control | Flexible management. Can have multiple members. | A single owner, with complete control over operations. |
LLCs and sole proprietorships may seem similar in many ways. Single Member LLC It’s similar to a sole proprietorship because it has one owner and is generally taxed the same way. Despite the similarities, there are important differences between the two business structures, which we’ll explore in more detail here, but be sure to consult with a tax professional before making any decisions that may affect your business.
responsibility
The most well-known difference has to do with liability. Overall, a limited liability company offers more personal liability protection. Forming a single-member LLC allows you to protect your personal assets, such as your home, car, and personal bank accounts, from liability claims against the company. If the LLC has debts, the owners also are not at risk of personal liability to repay those debts if the business cannot repay them on its own. This is because the business remains a legally separate entity from the owners.
In comparison, a sole proprietorship doesn’t protect you from debts or legal claims. You aren’t considered a separate legal entity. For example, if you incur business debts as a sole proprietor, you have no legal protection from lawsuits and your personal assets are held liable.
learn more: How to get a business license
tax
A single-member LLC offers more tax flexibility than a sole proprietorship: you can choose to be taxed as a sole proprietor or treated as a corporation. S Corporation (S corporation) or C Corporation A C Corporation is a qualified legal entity for income tax purposes. Although S Corporations can offer some of the pass-through tax benefits available to LLCs and sole proprietorships, S Corporations have very specific qualification and tax filing requirements. Small business owners should consult with a qualified tax advisor to determine the best structure for them.
A sole proprietor owns a business that is subject to pass-through taxation, meaning business income flows through the business and is reported on their personal tax return. Sole proprietors are required to pay self-employment taxes, which are estimated and paid quarterly. Self-Employment Tax Rates That’s 15.3 percent, which is a combination of Social Security and Medicare taxes.
We encourage you to consult with a tax professional when managing your taxes or making any financial decisions as an individual. Independent Contractor.
cost
There are more costs involved Forming an LLCIn most states, an LLC can have a separate legal entity name (also known as a Conducting business asor create a DBA and register it with the Secretary of State.
by U.S. Small Business AdministrationRegistration costs are usually under $300 but vary depending on your location and the type of business you do. Depending on your industry and state, you may also need to obtain licenses and permits. If you’re an LLC, you may have to pay ongoing fees to file annual reports and renew permits.
Sole proprietorships are generally free to start and have relatively low formation costs, as there are no formalities or paperwork involved. Although not required, some sole proprietors choose to register a DBA business name. DBA registration costs vary by location. As with LLCs, sole proprietorships should check their local business operating regulations for any required licenses or permits and associated costs.
learn more: How to register your business: what you need
Funding
The fundraising process for an LLC is usually easier. LLCs can raise capital in the following ways: Crowdfundingbusiness loans, and other financing options are available. Compared to a sole proprietorship, an LLC is generally considered a safer investment because it has a separate business entity status and investors’ personal assets are protected. Single-member LLCs also have the option to bring in additional partners to invest in the business.
Self-employed people generally have limited financing options. Many banks only issue personal loans to self-employed people, and they may have stricter restrictions on business use than a sole proprietor. Business Loans.
Management and Control
A sole proprietorship is owned and operated by only one individual. An LLC, on the other hand, has more flexibility when it comes to management and control. A single-member LLC can operate just like a sole proprietorship, with one owner overseeing the business operations. However, additional members can also be added, in which case the business owners share management and ownership.
With a sole proprietorship, the responsibility of running and managing the business rests with the individual owner with full authority. With a sole proprietorship, you also have more responsibility. You take on all the roles, Growth Strategy.
learn more: How to Form an LLC: Everything You Need to Know
Check out our state-specific LLC guides:
When should I start my own business?
Choosing a business structure is an important decision, and if you’re still unsure whether to set up a sole proprietorship or an LLC, take a moment to think about the following criteria:
We recommend you become a sole proprietor if:
- Your business is low risk. If your business is low risk, such as freelance writing or consulting, you may not need the liability protection that an LLC offers.
- Testing something new Business Idea. Forming and maintaining an LLC takes time and money. If your business idea is in the early stages, it may be easier to continue as a sole proprietor until you gain momentum. You can always convert your business to an LLC in the future.
- Your business is short term. for example, Side job Work as a floral designer in the summer. A sole proprietorship may be a better fit than forming an LLC.
When should I form an LLC?
If none of the above criteria fit your business needs, an LLC may be a good option. Here are some things to consider:
- Your business carries high risks. If you’re opening a retail store or managing your company’s bookkeeping, the protection that an LLC offers is valuable.
- You are planning to expand your business. If you plan on receiving outside investment or eventually want to add partners, an LLC makes it easy to onboard new members and investors.. If you plan to operate a business in another state, an LLC can make it easier to comply with state regulations.
- You want a professional business image. Forming an LLC can make your business appear more established to customers, suppliers, and investors.
Move new business forward
Incorporation You get official government recognition as a legal entity. You can protect your personal assets, build your company’s credit, and potentially enjoy tax breaks. An LLC can be more attractive than a sole proprietorship, especially as your company grows.
Whether you choose to form an LLC or become a sole proprietor; Turning an idea into a real, legitimate business Ultimately, it’s up to you.
Disclaimer: These guides are for informational purposes only and do not constitute professional legal or tax advice. Please consult independent legal and your own tax advisors for information specific to your country and situation. Shopify is not liable in any way for your use of or reliance on these guides.
Sole proprietorship and LLC FAQs
What is the biggest difference between a sole proprietorship and an LLC?
- tax. a Single Member LLC When certain entity elections are made, different tax consequences may result.
- responsibility. An LLC offers more protection when it comes to personal liability.
- cost. A sole proprietorship is free to start, but an LLC requires registration fees and ongoing fees.
- Funding. It is generally easier for an LLC to obtain outside financing than a sole proprietorship.
- Management and control. A sole proprietorship has more management control than an LLC.
What are the disadvantages of an LLC?
- Dealing with government bureaucracy. Because LLCs are governed by federal, state, and local jurisdictions, you may need to handle licenses, permits, and administrative tasks depending on the nature of your business.
- Fee. An LLC has more associated costs than a sole proprietorship.
What are the disadvantages of a sole proprietorship?
- Personal responsibility. The owner of a sole proprietorship is responsible for all debts and losses incurred by the business.
- Difficulty raising funds. Investors are less likely to support sole proprietorships because they are perceived as a less formal business entity.
