Sole Proprietorship vs. LLC—What’s the Difference?
Starting a business is an exciting process. But before you get your business up and running, one of the first things you must do is select a business structure.
In fact, selecting your business structure is one of the most important things you will do. The type of structure you choose will determine many things for your business moving forward. These things include:
• How your business will be managed;
• Tax implications; and
• What your personal liability protections will be.
There are many different types of business structures you can choose from. However, two of the most common are the sole proprietorship and the limited liability company (LLC).
If you have questions about the difference between an LLC and sole proprietorship or if you need guidance as you decide which to select for your business, look no further.
What Is the Difference Between an LLC and Sole Proprietorship?
Your business’s legal structure will have a major impact on how your business functions. Thus, it is imperative that you understand the difference between an LLC and sole proprietorship so that you can make the best decision for your business and its needs.
Forming a Texas limited liability company requires filing a certificate of formation with the Texas Secretary of State (TXSOS). An LLC is its own distinct type of business entity that is neither a corporation nor a partnership. In an LLC, the business is owned by one or more “members” and can be managed by either its members or separate “managers.”
A sole proprietorship, on the other hand, is the simplest form of business entity. In a sole proprietorship, a single individual owns and operates the entire business. No formal filing or registration with the state is required. However, if your sole proprietorship is conducted under an assumed name (also known as a “doing business as” or DBA), you need to file an assumed name certificate with the county clerk’s office in which the business premise is maintained. An assumed name is any name other than your own.
What Liability Protections Should I Expect in an LLC vs. Sole Proprietorship?
One of the key differences between an LLC and a sole proprietorship is the level of personal liability protections afforded to owners and members. Having an understanding of these liability protections can help inform what type of business entity is right for you.
Sole Proprietorship Liability Protections
Sole proprietorships are the easiest business to form. Unfortunately, however, a sole proprietorship does not provide as robust liability protections as those that exist for an LLC.
One of the main disadvantages of a sole proprietorship versus an LLC is that a sole proprietor is personally liable for the debts incurred by the business. This means that if you incur debt as a result of conducting your business, debtors can go after your personal property and assets to satisfy those debts.
LLC Liability Protections
An LLC is more difficult to form than a sole proprietorship. However, depending on your specific circumstances, registering your business as an LLC may be worth the additional steps to form one.
Unlike a sole proprietorship, an LLC provides personal liability protection for its members.
An LLC member is personally liable only up to the amount that member invested in the LLC. That means that debtors cannot seek out members of the LLC individually in an attempt to recover debts of the business.
Taxation Considerations in a Sole Proprietorship vs. LLC
As discussed above, a sole proprietorship has only one individual and requires no registration with the state. Accordingly, a sole proprietorship’s income is also the individual sole proprietor’s income.
A sole proprietor must report the income and losses of the business on their personal income taxes. No additional employer identification number (EIN) is necessary. However, sole proprietors must still pay a self-employment tax.
LLCs, on the other hand, are separate business entities subject to a franchise tax in Texas. Generally, an LLC is taxed as a pass-through entity. This means that all profits of the business “pass through” the LLC to its owners/members. Those owners/members then report those profits on their own personal tax returns.
Taxation rules in an LLC vs. sole proprietorship can seem confusing and complicated. An experienced business law attorney can help you understand the differences between the two types of entities and guide you toward choosing the type of entity that will work best for your business.
Sole Proprietorship vs. LLC: Which One Do I Need?
There are various differences between LLCs and sole proprietorships. But neither type of entity is necessarily better than the other. Really, it just comes down to the specific needs and desires you have for your business.
Always consult a business law attorney for help determining which entity might be best for you.