Questions To Answer:
- Is a single member LLC the same as a sole proprietorship
- Is an LLC better for taxes
- What are the advantages of Changing from a sole proprietorship to an LLC?
- Is a single Member LLC worth it?
- Limited Liability Company
- Sole Proprietorship
Small business owners are establishing limited liability companies (LLCs) all over the country to protect their assets and interests. According to The Balance SMB, an LLC is a business structure that is entirely owned by its members and is much simpler in design than a corporation. A sole proprietorship is another type of business structure. Entrepreneur defines a sole proprietorship as a company that is not legally distinct from its owner. Many small businesses in the country today get started as sole proprietorships. Eventually, they consider becoming LLCs, but is this consideration warranted? What is the difference between an LLC and a sole proprietorship?
LLCs bring with them a lot of benefits for a small business owner. They operate as pass-through taxation structures, meaning that the business usually saves on taxes. These savings can actually be used to pay for the company's continued registration and have a lot left over for the members. However, an LLC may file to be taxed as an S-Corp of a corporation, giving it flexibility in its tax payments. When registered as either of those corporation types, the business is taxed as a partnership. The most well-known benefit that an LLC offers to its members is liability protection. Usually, when conducting business, business owners may find themselves the subject of a lawsuit. Having an LLC ensures that, if the matter goes to court, the claimant can only file for settlement on the company's assets, not on those held by the owner.
Some states allow LLCs to be formed anonymously. In this case, the members of the LLC are kept off the public record. An anonymous LLC guarantees privacy to the members of an LLC. However, it is vital to remember that a court can subpoena the registered agent to divulge the members' names, so it doesn't grant complete anonymity from the consequences of a business's actions. Businesses that register as an LLC tend to be seen as more professional by clients. Specialists benefit a great deal from this distinction. The only downside of registering a business as an LLC is the nominal costs and complexity in filing articles of organization.
As mentioned before, sole proprietorships are unregistered business entities. From the perspective of the law, the owner and the business are the same individual. Sole proprietorships are also known as sole traders. They are the simplest form of business since they need no documentation for their formation. However, the complications may arise almost immediately. Since all of the sole trader's profits count as income, they may be subject to a very high tax rate, paying much of their earnings to the IRS. Unfortunately, these sole proprietorships do not appear very professional to the public. While there is less complexity operating as a sole trader, there is also the looming threat of lawsuits.
Business lawsuits happen more often than you'd think. In some cases, the matter goes to court. A sole proprietor is seen the same as their business. In the eyes of the law, their assets are fair game for a lawsuit. Sole proprietorships are also very hard to expand and raise funds for growth. Because their position in the economy is seen as unprofessional, it's almost impossible to find investors, no matter how profitable the business idea may seem.
Sole proprietorships are informal businesses, meaning that they cost nothing to establish. Filing articles of organization for an LLC does require a nominal fee, but it's more than what a sole proprietorship requires. LLCs are typically more professional organizations, while sole proprietorships show up as hobby organizations of part-time jobs that people do on the side for extra income. LLCs can be seen as a hybrid of partnerships and corporations, allowing for a single member or group of members to benefit from the best parts of those business structures.
Aside from the initial startup costs, LLCs are also managed differently than sole proprietorships. In a sole trader organization, the owner runs the business. An LLC can set up a management structure independent of its members or have a member serve as its manager if the board is so inclined. Sole traders are also responsible for 100% of the liability of their organizations since they are considered the same person legally. LLCs protect member assets from liability, ensuring that if the business does get taken to court, the court can only assign compensation from the business's holdings.
The IRS sees sole proprietors as self-employed. The income they make from their business goes towards their taxable income. This usually means that their month-to-month taxes may vary widely as they move between tax brackets. Additionally, the personal income tax rate is massive compared with the same business rate. LLCs have flexibility in their taxation arrangement. Usually, an LLC is seen as a pass-through business structure for taxation. If it maintains this status, the IRS sees it as a disregarded entity. However, the LLC may also be taxed as an S-Corp or corporation. In this case, the business is viewed as a partnership for taxation purposes. The taxation regime varies between these two business structures, but it's clear that legitimate businesses would benefit from one instead of the other. For hobbyists and enthusiasts just doing something because they love it, remaining as a sole proprietorship may be in their best interests.
Which is the better business structure? Generally, sole proprietorships are better for people who don't want to legitimize their business for whatever reason. It may be because it doesn't turn enough of a profit to register it independently or that it's just a hobby. LLCs, on the other hand, offer legitimacy for professionals and entrepreneurs. In most cases, if you have a business that turns a significant profit, it may be in your best interests to register it as an LLC. The process is simple, and in most cases, you can find a lawyer that will guide you through the process and correct issues with your documents.