Sole Proprietorship vs. LLC: Key Insights You Need to Know (2024)

While starting your own business is certainly exciting, it often requires some not-so-exciting decisions, like choosing a business structure.

One of those decisions could be whether to launch as a sole proprietorship or an LLC. This decision can have a major impact on your compliance obligations, how you pay taxes, and your personal liability.

This guide compares the differences between sole proprietorships and LLCs to help you decide which business type is right for you as a new business owner.

What is a sole proprietorship?

A sole proprietorship is the most basic type of business. It is an unincorporated business owned by a single individual, with no legal separation between entity and owner. If you own a sole proprietorship, you solely control the business and its income. Your business profits pass through to your personal tax return and are taxed at the individual rate. 

Creating and operating a sole proprietorship is a relatively simple process, making it a popular choice among the self-employed (like freelancers), small business startups, and low-risk businesses like print-on-demand companies. Unless you’ve taken any steps to legally establish your business, it’s a sole proprietorship by default. There’s no formal registration or filing process required to start this type of business.

Read our in-depth guide to the advantages and disadvantages of operating a sole proprietorship to learn more.

Pro tip: Laws for sole proprietors vary by state and nature of business. It’s always best to check with your local jurisdictions to find out what the requirements are for setting up your sole proprietorship, as well as noting any necessary tax filings, licenses, or permits.

What is an LLC?

An LLC, or limited liability company, is a type of business structure that is either owned by a single person or entity, or owned jointly by multiple partners, called members. LLCs offer liability protections for their owners, similar to corporations, but taxation is similar to sole proprietorships.

As an LLC, your business’s profits pass through to each member, and taxes are paid at personal tax rates. There is legal separation between the business entity and owner. This protects owners (you and your partners) from personal liability for the business’s debts and legal claims, although the extent of protections may vary by state. An LLC also can establish its own business credit. LLCs are popular with consultants and ecommerce businesses, for example, due to their flexibility and liability protection.

There are many types of LLCs, each with different parameters. The single-member LLC, the most comparable to a sole proprietorship, consists of just one owner who controls 100% of the business.

LLCs are formed in the state in which they operate, and typically require you to get a federal employer identification number (EIN) and complete paperwork such as certificates of formation or articles of organization. Documentation requirements can vary by state.

Learn more about the advantages of forming an LLC.

LLC vs. sole proprietorship: what’s the difference?

LLCs and sole proprietorships can appear similar in many ways. A single-member LLC resembles a sole proprietorship because it also has one owner and is generally taxed the same.

Despite similarities, there are key differences between the two business structures. Here’s a closer look at how they differ. But before you make any decisions that can affect your business, always consult a tax professional.

Liability

The most well-known difference involves liability. Overall, a limited liability company offers more personal liability protection. When you form a single-member LLC, you shield your personal assets such as your house, car, and personal bank accounts from liability claims against the company.

If the LLC has debts, the owner also doesn’t risk any personal liability to pay off those debts if the business can’t do so on its own. That’s because the business remains a legally separate entity from the owner.

Sole proprietorships, by comparison, don’t shield you from debts and legal claims. You are not considered a separate legal entity. For example, if you face business debts as a sole proprietor, you have no legal protection from a lawsuit and your personal assets are exposed to liability.

Note, however, that the protection LLCs offer isn’t perfect, though. If an owner mixes their personal money with business money or does something dishonest, the courts might decide the owner is personally responsible for the business’s debts. This is called “piercing the corporate veil.” 

Learn more: How To Get a Business License

Taxes

A single-member LLC offers more tax flexibility than a sole proprietorship. You can choose to be taxed as a sole proprietorship or elect to be treated as an S corporation (S corp) or C corporation (C corp) for income tax purposes. While S corporations could offer some of the pass-through tax benefits enjoyed by LLCs and sole proprietorships, S corps have very specific requirements for eligibility and tax filings. Small business owners should consult with a licensed tax adviser to determine the best structure.

As a sole proprietorship, you own a business that has pass-through taxation, meaning business income flows through your business and is reported on your personal tax returns. Sole proprietors are required to pay self-employment taxes, which are estimated and paid quarterly. The self-employment tax rate is 15.3% and is a combination of Social Security and Medicare taxes.

It’s a good idea to consult a tax professional when managing your taxes and making financial decisions as an independent contractor.

Costs

There are more costs associated with starting an LLC. Most states require LLCs to create a separate entity name (also known as doing business as, or DBA) and register with the Secretary of State.

LLCs have regular costs that can build up, depending on your state. Most states make LLCs file a report every year or two, which can cost $50 to $500. This is on top of the first fees to start the LLC, usually between $50 and $150. LLCs also need to follow local business rules and get the right licenses.

Sole proprietorships cost much less to run. After you set up the business, you only need to pay to renew your business name (if you have one) and any needed licenses. Unlike LLCs, sole proprietorships don’t have to file state reports or meet extra rules. This makes them easier and cheaper to keep going over time.

Learn more: How To Register a Business: What You Need to Do

Funding

The funding process is usually easier for LLCs. They can raise capital through crowdfunding, business loans, and other financing options. Compared to sole proprietorships, LLCs are generally viewed as safer investments due to their separate business entity status, which protects investors’ personal assets. A single-member LLC also has the option of bringing on additional partners to invest in the business.

Sole proprietorships typically have more limited financing options. Many banks will only issue sole proprietors personal loans, which may be more restrictive about business use compared to business loans.

Management and control

A sole proprietorship can only be owned and operated by one individual. While LLCs have flexibility when it comes to management and control. Single-member LLCs can operate the same way as sole proprietorships, with one owner overseeing business operations. However, you have the option to bring on additional members. In such cases, business owners have shared control and ownership.

With sole proprietorships, the responsibility of business operations and management rests with an individual owner who has complete control. If you own a sole proprietorship, you also incur more responsibility—and it can be challenging to take on all roles and implement a growth strategy.

Legal requirements

Each state has its own rules you need to follow to form an LLC. One big step is picking a name for your business. Your LLC’s name has to be different from other businesses in your state. Also, you can’t use some words like “bank” or “insurance” unless you have special permission.

Some states have extra steps. For example, in New York, you have to put an ad in local newspapers saying you’re starting an LLC. This can cost more money and make the whole process take longer. These extra rules can mean it takes more time before you can officially open your business.

Credibility 

Setting up an LLC can also make your business look more serious and professional. This can be a big plus when dealing with possible investors, partners, and customers.

Many investors don’t like working with sole proprietorships because the owner and the business are legally the same. Having an LLC can make it easier to get money for your business or find partners. It shows that you’re committed to running a more organized business that follows the rules.

Learn more: How To Start An LLC: Everything You Need to Know

When should you form a sole proprietorship?

Choosing your business structure is an important decision. If you’re still on the fence about forming a sole proprietorship or an LLC, take a minute to consider the following criteria.

You’ll want to form a sole proprietorship if:

• Your business is low risk. If your business is low risk, like freelance writing or consulting, you may not need the liability protection offered by an LLC.
• You’re testing a new business idea. Creating and maintaining an LLC takes time and money. If your business idea is in the early stages, it’s probably easier to continue as a sole proprietorship until you get more traction. You can always convert your business into an LLC down the road.
• Your business is a short-term. Say you’re running a side hustle as a floral designer in the summer. A sole proprietorship may be more suitable versus forming an LLC. 

When should you form an LLC?

If none of the criteria above match your business needs, an LLC might be a good option for you. Here’s what to consider:

• Your business will be high risk. If you’re opening up a retail store or managing bookkeeping for companies, the protection an LLC offers can be worth it.
• You plan to grow your business. If you plan to get outside investment or eventually want to add partners, an LLC can easily accommodate new members and investors. It’s also easier to navigate state regulations with an LLC if you plan to operate in another state. 
• You want a professional business image. Forming an LLC can make your business appear more established to customers, suppliers, and investors.

Convert your sole proprietorship to an LLC

Converting your sole proprietorship to an LLC involves several key steps.

First, choose a unique name for your LLC and file Articles of Organization with your state’s business office. You’ll need to pay a filing fee, which varies by state.

Next steps include:

1. Selecting a registered agent
2. Creating an operating agreement
3. Obtaining a new EIN from the IRS

Update your business accounts, licenses, and permits to reflect the new LLC structure. Don’t forget to inform customers and vendors about the change.

Transfer business assets to the LLC and register for state taxes if required. Update your marketing materials with the new LLC name. State laws vary, so it’s wise to consult with a lawyer or accountant for specific advice tailored to your situation.

Move forward with your new business

Incorporating a business makes it official in the eyes of the government. You protect your personal assets, build credit for your company, and, in some cases, even enjoy lower taxes. This can make an LLC more appealing than a sole proprietorship, especially as your company grows. 

Whether you choose to form an LLC or a sole proprietorship, transforming your idea into a real, official business is ultimately up to you.

DISCLAIMER: These guides are for informational purposes only and do not constitute professional legal or tax advice. Please consult independent legal advice and your own tax advisers for information specific to your country and circumstances. Shopify is not liable to you in any way for your use or reliance on these guides.