LLC or sole proprietorship?
How each one starts
The IRS describes a sole proprietor as someone who owns an unincorporated business by themselves. There's no formation document, so you're one as soon as you work for yourself. The SBA notes that some businesses don't need to register at all, though you may still need a DBA to trade under a name that isn't yours, plus any local license.
An LLC exists only once a state accepts your articles of organization and its fee. Montana charges $35 and Massachusetts is the highest; our state fee list has all 51. You also name a registered agent and, in most cases, get an EIN. How to start an LLC is the full order of steps.
Liability is the real difference
The SBA puts the sole proprietorship plainly: your business assets and liabilities are not separate from your personal assets and liabilities, and you can be held personally liable for the debts and obligations of the business. One unpaid supplier or one lawsuit reaches your own money.
With an LLC, the SBA says your personal assets, such as your vehicle, house and savings accounts, won't be at risk if the LLC faces bankruptcy or lawsuits. That holds in most instances, not all. A loan you personally guarantee is still yours, harm you cause yourself is still yours, and a court can look past the company if it was never kept separate from you. Keep the money in a business bank account, and carry insurance either way, because an LLC guards your assets and doesn't pay the claim.
Taxes come out the same at first
A sole proprietor reports the business on Schedule C with Form 1040, pays self-employment tax on Schedule SE and often makes estimated payments with Form 1040-ES. For federal income tax the IRS treats an LLC with one member as an entity disregarded as separate from its owner, so the profit goes on the same Schedule C. Forming an LLC on its own changes neither your income tax nor your self-employment tax: the SBA says LLC members are considered self-employed too.
What an LLC adds is a choice. It can elect to be taxed as a corporation with Form 8832, and an eligible LLC can elect S corporation status with Form 2553, which LLC or S corp goes through. A sole proprietorship has no such election, because there's no entity to make it. Whether an election saves you anything depends on your numbers, so ask an accountant.
One more difference: the IRS treats a disregarded single-member LLC as a separate entity for employment tax and certain excise taxes, so an LLC with employees uses its own EIN.
What each costs to keep
A sole proprietorship has no state filing to renew. An LLC usually does: most states want a report, a fee or both every year or two, from $18 in Utah to California's $800 annual tax, and a few states such as Ohio ask for no annual report at all. Annual reports by state has each one, and those are the dates to put on a calendar.
Which one fits you
The SBA says a sole proprietorship can be a good choice for low-risk businesses and owners who want to test a business idea before forming a more formal business. It also points out the limits: you can't sell stock, and banks are hesitant to lend to sole proprietorships.
An LLC is worth the fee once there's something to lose. Signs it's time: customers in your home or on your property, products that could hurt someone, a lease or a contract with real money in it, your first hire, or a second owner, which a sole proprietorship can't have at all. LLC pros and cons weighs it up, and best state to form an LLC covers where.
Switching from one to the other
You don't convert a sole proprietorship. You form the LLC, then move the business into it: open a bank account in the LLC's name, put new contracts and invoices in that name, move licenses and permits over, and tell your insurer. If you trade under a DBA, register it again under the LLC or name the LLC that.
On the EIN, the IRS says a single-member LLC that isn't taxed as a corporation and has no employees or excise tax liability can keep using the owner's number, while other changes can require a new one. Check how to get an EIN before you apply for a second one you don't need.
Questions
Is a single-member LLC the same as a sole proprietorship?
No. Under state law the LLC is a separate company. For federal income tax the IRS disregards it and the profit goes on Schedule C, which is how a sole proprietor reports too, and that's the part people mix up.
Do I pay less tax as an LLC?
Not by forming one. A single-member LLC is reported on the same Schedule C, with the same self-employment tax. An LLC can elect corporate or S corporation treatment, which a sole proprietorship can't, and whether that helps depends on your numbers.
Is a sole proprietorship free to start?
There's no formation filing, and the SBA says some businesses don't need to register at all. A DBA, a local license or a permit can still cost something, depending on where you work and what you sell.
Can a sole proprietorship have two owners?
No. The IRS describes a sole proprietor as someone who owns an unincorporated business by themselves. Two or more owners means a partnership or a multi-member LLC.
Does an LLC protect me from everything?
No. The SBA's protection is in most instances. Debts you personally guarantee and harm you cause yourself are still yours, a court can look past a company that was never kept separate from its owner, and insurance is what pays a claim.
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