LLC or sole proprietor: the basics for small-business owners

Many small businesses start as a sole proprietorship without anyone formally deciding it. If you begin selling a product or a service on your own and do not form a separate legal entity, you are generally operating as a sole proprietor. A limited liability company, or LLC, is a different setup: it is a business entity you create by filing with your state. This article explains the basic differences in plain language so you can have a better-informed conversation about what fits your business.

What each one is

Sole proprietorship

A sole proprietorship is the simplest way to run a business. There is one owner, and the business and the owner are treated as the same person. There is usually no formation filing with the state to create it, although you may still need local licenses, permits, or a registered business name depending on where you work and what you do.

Because the business and the owner are the same, the business income is the owner's income. The business debts are also the owner's debts. That simplicity is the main appeal. It is easy to start and easy to understand.

LLC

An LLC is a legal entity that is separate from its owner or owners. You form it by filing documents with the state where you organize the business, and states typically charge a filing fee. Many states also have ongoing requirements, such as an annual report or renewal, to keep the LLC in good standing.

An LLC can have one owner, often called a single-member LLC, or several owners. The rules, fees, and renewal requirements vary from state to state, so it is worth checking what applies where you plan to form it.

The general idea of liability separation

Liability is the main reason many owners look at an LLC. In general terms, an LLC is designed to keep the business's debts and legal obligations separate from the owner's personal assets. With a sole proprietorship, there is no such separation.

That protection is not automatic or unlimited. How well it holds up can depend on the situation, on state law, and on how the business is run. For example, mixing personal and business money, or personally guaranteeing a loan, can affect it. For questions about your legal protection, an attorney is the right person to ask.

How taxes generally work for a single-owner LLC

Forming an LLC does not necessarily change how the business is taxed. A single-owner LLC is commonly treated like a sole proprietorship for federal income tax purposes. The business profit is reported on the owner's personal return, much as it would be without the LLC.

An LLC can choose a different tax treatment by making an election with the IRS, such as being taxed as an S corporation. Whether an election makes sense depends on the business's profit, how the owner is paid, and other factors. It is a decision to make with real numbers in front of you, not a default step. If you would like to talk through the tax side, our tax and advisory services are a good place to start.

Keep business and personal money separate either way

Whichever structure you choose, keeping business and personal money apart makes everything easier. A few simple habits help:

• Open a bank account used only for the business.
• Pay business expenses from the business account, not a personal card.
• Pay yourself on purpose, with a recorded transfer, instead of mixing personal purchases into business accounts.
• Keep receipts and records for business expenses.

For an LLC, this separation also supports the idea that the business is its own entity. For a sole proprietor, it makes your books cleaner, your tax preparation simpler, and your numbers easier to understand. Clean records are also what make monthly bookkeeping work well.

Which one is right for your business

There is no single right answer. A sole proprietorship can be a reasonable choice for a small, lower-risk business that is just getting started. An LLC may make more sense when the business has more risk, more assets, employees, or partners, or when the owner wants a clearer line between the business and personal life. Cost and paperwork matter too, since an LLC comes with state fees and ongoing requirements.

The right choice depends on your type of work, your risk, your plans, and your state. For legal questions, talk with an attorney. For the financial and tax side, we are happy to help you think it through.

Choice Business Advisors offers LLC formation support starting at $150. Government and state filing fees are separate and depend on the state. You can see the details on our tax and advisory page.

Talk with us about your business

If you are deciding between staying a sole proprietor and forming an LLC, we can walk through what you know so far and which questions to bring to an attorney. We work with owners in English and Spanish. Start a conversation with us whenever you are ready.

Written by the team at Choice Business Advisors, a bookkeeping, tax, and advisory firm based in Utah serving small businesses across the United States in English and Spanish.