Should I Form a Sole Proprietorship or a Single-Member LLC?

One of your first responsibilities as an entrepreneur will be to decide how to structure your business. If you are the only owner, you have a couple of different options to choose from, including forming a sole proprietorship or a single-member LLC. While the differences between these two may seem slim at first, you will likely notice the effects on your business in the form of taxes, liability, and more over time.

To make an informed decision, you should understand the advantages and disadvantages of each and take the time to consider which option best suits your needs. This guide will share the key differences you need to know when comparing a sole proprietorship to a single-member LLC.

What Is a Sole Proprietorship?

If you have started doing business of any kind, and you are the sole owner, then by default, you are already practicing as a sole proprietorship. This type of business is unique because state governments generally don't require you to register a sole proprietorship. 

As the owner, there is no legal distinction between you and the business. This definitely saves some paperwork, but the downside is if something goes wrong and you get sued or owe money, you will personally be on the hook. Your assets, including your savings, home, and vehicle, could be seized to pay off overdue debts. 

In the United States, entrepreneurs operate an estimated 23 million sole proprietorships. If you need help determining if you already qualify as a sole proprietorship, explore the IRS's sole proprietorship information page online.

What Is a Single-Member LLC?

Often, owners doing business as a sole proprietorship decide to form a single-member LLC. This provides a legal separation for the owner between themselves and the business. Once the single-member LLC is formed, the owner is no longer personally responsible for the company's legal actions or debts. As the name implies, a single-member LLC has only a single member or owner. This differs from a typical LLC, which can have several owners. 

Before becoming a single-member LLC, you must file paperwork in the state in which you do business. You can find more information about LLC requirements on the IRS LLC information page online.

Pros & Cons of a Sole Proprietorship 

Millions of businesses choose to operate as a sole proprietorship. However, this business structure may not be right for everyone. Below are some of the pros and cons you may want to think about when considering a sole proprietorship.

Sole Proprietorship Pros

• Quick and easy set up

• No forms to fill out

• Control over the business decision and income

• No annual paperwork

Sole Proprietorship Cons

• No separation between owner and company

• Owner responsible for all debts, obligations, and liabilities

• Difficult to raise capital

• No tax advantages

• May appear less professional than an LLC

Pros & Cons of a Single-Member LLC

While a single-member LLC may require additional steps to form, they offer owners several advantages over a sole proprietorship.

Single-Member LLC Pros

• Can give owner limited liability protections from debts and other obligations

• Offers personal asset protection

• Can be taxed as a corporation

• Flexible tax structures to choose from

• Can add additional partners and management 

• More options to take on investors and raise capital

Single-Member LLC Cons

• Formation costs

• Annual fees

• Annual filing and paperwork

• Limited liability can have limits in some cases

Key Differences 

There are some crucial differences between a sole proprietorship and single-member LLC. For an owner, deciding which to choose will likely come down to key areas like liability, taxes, and time.

Personal Liability

When you are operating your business, you run the risk of individuals being injured or other personal property becoming damaged. If a client or customer feels like harm was caused as a result of your business, they can seek compensation through the courts. If the legal action requires payment, the court can determine if the business or the owner is liable for damages.

Sole Proprietor

As the sole proprietor, if your business is sued, your personal assets, including your savings, home, and vehicle, can be lost to pay back any debts or damages.

Single-Member LLC

LLC is short for a limited liability company. As the name implies, it limits your personal liability when it comes to the debts, damages, and other obligations your business may incur. For the owner, this helps protect your personal assets. If your LLC is sued and found responsible for damages, they must be paid out from your business's assets and not your own. 

However, while offering significantly more protection than a sole proprietorship, an LLC isn't a get-out-of-jail-free card. It doesn't allow you to conduct business dishonestly, and fraud or other irresponsible actions can "pierce the corporate veil" in the court's eyes. In this case, you can still be held personally responsible for damages. 

Some courts might also consider single-member LLCs too similar to a sole proprietorship and choose to hold the owner personally liable. To limit your personal liability further, you may consider forming a traditional LLC with two or more partners. 

Taxes

Taxes play a huge role in any business. As the owner, how you are taxed can mean the difference between profitability and closing the doors. While taxes for a sole proprietor are relatively straightforward, forming an LLC expands your options considerably.

Sole Proprietor

Sole proprietors and their businesses are considered the same tax-paying entity by the IRS. All business profits and tax obligations are passed through to the owner, taxed according to their individual tax rates, and subject to self-employment taxes, including Social Security and Medicare.

Single-Member LLC

Forming an LLC offers additional taxation options. By default, a single-member LLC will be considered a disregarded entity. In this case, your business taxes will be the same as your own, identical to a sole proprietorship. However, as an LLC, you will have the option to choose to be taxed as either a C Corporation or S Corporation. 

With a C Corporation, any business income will be taxed at the corporate rate, and the business will need to file a tax return. Owners of C Corp may also receive distributions, which are taxed at the individual level. 

With an S Corporation, income and losses pass through to the owner's tax returns, similar to a sole proprietorship.

Ongoing Requirements 

Depending on the type of business structure chosen, there may be ongoing business requirements placed on the owner, including annual filings, paperwork, or fees. 

Sole Proprietor

If you are worried about tedious paperwork eating up your time, a sole proprietorship has its advantages. As a sole proprietor, there is no extra paperwork required because the state considers you and your business to be the same.

Single-Member LLC

Forming an LLC requires you to remain compliant with state requirements. These requirements may include:

• Filing an annual or biannual report with your state

• Maintaining separate banking accounts for your business

• Reporting any major changes to the LLC to the state by filing an Articles of Amendment

Fortunately for LLC owners, there are services available that can help with the ongoing paperwork, allowing you to focus your time on running the business. 

Form Your LLC Online With Swyft Filings

If you decide an LLC is your best option moving forward, then the small business experts at Swyft Filings can help. We offer several services for sole proprietors looking to make the switch that can save you time and money. Our online service can help you form your LLC online in just minutes. Plus, we offer services to help minimize your paperwork and costs every year. To get started, visit our LLC formation page or give us a call at 877-777-0450.