A limited liability company (LLC) is a business entity type that offers its owners limited liability protection. It is often viewed as a hybrid structure that combines the pass-through taxation benefits of a sole-proprietorship (or partnership) with the liability protection of a corporation.
There are many advantages that your business can enjoy by choosing to form an LLC. Often times the most sought after advantage of an LLC is the liability protection that shields owners from lawsuits and other debt obligations. With a properly formed and maintained LLC, your personal assets will be safe from any potential business liabilities.
Also, LLC owners will find that it’s much simpler to secure equity investment and debt financing with a business entity that is separate and distinct from their personal finances. You’ll have a much easier time establishing credit for your business and find that you have better opportunity for loans, leases, and more. The LLC structure also enjoys a higher market credibility than that of a sole-proprietorship.
As you consider which entity type is right for your business, note that there are a few disadvantages associated with LLCs, as well. There are ongoing administrative matters to handle, such as the paperwork and fees associated with formation and subsequent annual filings. Depending on the nature of your business this can include industry-specific licensing fees.
A sole-proprietorship is an unincorporated entity type that is essentially just a sole individual that owns and operates a business. This individual owner will report business profits on their personal tax return and be personally responsible for any business debts.
There are a number of advantages that sole-proprietorships can enjoy. For example, a sole-proprietorship won’t have to fill out formation paperwork with the state or file any annual reports. Note, however, that certain industries might have their own licensing or filing requirements that you’ll want to be sure to follow.
Additionally, all of the profits and losses from your business will be reported on your individual tax return, meaning that you’re responsible for federal, state, local, and FICA taxes but not for any additional business or unemployment taxes. There’s also the possibility that you’ll be able to write off some of your expenses as business expenses.
There are a few notable disadvantages associated with sole-proprietorships, as well, that you should keep in mind. For example, sole-proprietorships do not enjoy the limited liability protection that LLCs offer. This means that you’re vulnerable to lawsuits, commercial debts, and other potential obligations that will put your own personal assets in jeopardy.
Additionally, sole-proprietorships are not likely to attract investors or be able to establish business credit, as financial institutions will approach the request as a personal loan. These factors will limit the growth potential of your business. Also, if you don’t utilize a DBA name for your sole-proprietorship, your business will likely face lower market credibility.
You may have noticed some of the distinctions between LLCs and sole-proprietorships from the characteristics listed above. However, there are a few key differences between the two that are worth highlighting in greater detail.
When it comes to formation, the simplest option is a sole-proprietorship, as there are no state registration requirements of filing fees of any kind. Note, however, that this is because sole-proprietorships tend to be small operations run by a single person without any employees.
Forming an LLC, on the other hand, requires formal registration at the state level. This process varies some from state to state but typically includes filing articles of organization and paying a filing fee with the Secretary of State’s office or Division of Corporations in your state.
When it comes to protecting your personal assets, there is a key difference between LLCs and sole-proprietorships. When formed correctly and kept in good standing with the state, LLCs offer its owners limited liability protection. This means that a member’s liability can only extend to the amount of their investment into the LLC, not to their personal assets.
A sole-proprietorship, on the other hand, is liable for any debts or obligations that might be incurred by the business. In such a scenario, the sole-proprietor’s personal assets could be in jeopardy. Owners of an LLC, however, would not be liable for any such debts.
When it comes to taxes, if your business is a sole-proprietorship then its income is considered personal income and will be reported on your personal tax return.
LLCs, on the other hand, have the option of electing to be taxed as a corporation or to be taxed as a sole-proprietorship or partnership. The latter option is the default classification for LLCs. This means that LLCs enjoy pass-through taxation in the same way that sole-proprietorships do, as profits from the business are reported on the owner(s) personal tax returns.
The main difference between these two when it comes to taxation is the fact that LLCs have the option to be taxed as a corporation, whether a C-corporation or S-corporation, while sole-proprietorships do not have this option.
When it comes to choosing which entity type is best for your business, the answer should boil down to your specific business goals and priorities. For example, if you run a small operation with very little potential for risk and are not looking to grow your business, you may determine that it’s not worth the additional registration and costs of an LLC.
Keep in mind, however, that few business owners ever regret having liability protection in place. The protections that an LLC can offer you and your business may greatly outweigh the relatively minor cost and effort associated with forming and maintaining your LLC. This protection to your personal assets is something that a sole-proprietorship just simply cannot provide.