There are a number of considerations that are important when starting a business. This is one of the very first decisions you’ll make in your business. When it comes to deciding whether to choose a sole proprietorship or LLC, many new entrepreneurs are left asking themselves, “What should I do?” Both can be used successfully, but they have varying levels of protection, cost, flexibility and responsibility.
It is generally simpler and less expensive to establish a sole proprietorship. An LLC provides greater legal safeguards and could be advisable as your business expands. The right option will depend on your business activities, financial risk, income and long-term plans.
In order to avoid issues later, it is essential to know the differences prior to registering your company.
What Is a Sole Proprietorship?
You might already be a sole trader if you begin to sell products or services without forming a new legal business structure.
Generally, there is no distinction between your and the business’ legal entities. You are the owner of the business, the one that runs it, and the one who gets the profits, and you are responsible for the debts of the business.
This simplicity is why sole proprietorships are used by freelancers, consultants, independent contractors and those just trying out a new business idea.
You may still require local licenses, permits, registrations or “doing business as” names, depending on where you are running your business.
What Is an LLC?
LLC is an abbreviation for limited liability company.
An LLC is a legal entity that is separate from its owner(s). This separation may be beneficial to an owner in the event of certain debts or legal claims being levied against the company.
Single or multiple owners are acceptable for LLCs. A one owner company is often referred to as a single member LLC.
Typically, you must file LLC formation documents with the appropriate state agency and pay formation fees to establish an LLC. Any other annual reporting or renewal fees may be required, as well.
While the LLC designation is more time-consuming than a sole proprietorship, some business owners opt for it due to the added legal separation it provides.
Sole Proprietorship vs LLC: What Should You Choose?
The decision between an LLC or a sole proprietorship is based primarily in the amount of risk you are willing to undertake and how you intend to run your business.
If you are launching a small business that poses little risk and you are looking to minimize documentation and expenses, a sole proprietorship could be the sole option for you.
If your business has customers, employees, contracts, valuable equipment, a large amount of revenue or any situation where there might be legal claims, an LLC may be a better option.
Both are not necessary for every entrepreneur.
Before making your decision, keep the following differences in mind.
Personal Liability Protection
One of the most significant differences between the two structures is that one has liability protection.
Sole Proprietorship
A sole proprietorship does not generally result in a separation between the business and the owner.
Should the business be liable for money or are subject to a lawsuit, the owner’s personal assets may be at risk. This can be personal savings, or other property, depending on the facts and applicable law.
For some small or low risk businesses, that risk might be okay, but it is more important as the business grows.
LLC
Typically, an LLC protects the company against its owners.
In the event that the business is in default on a debt or if a claim is filed against the business, a proprietor’s personal assets are normally more protected than in a sole proprietorship situation.
LLC protection is not absolute, though. Owners can remain personally liable for personal misconduct, personally obligated for debts, some tax liabilities, or where legal safeguards have been overlooked.
Startup Costs
The cost is another factor to consider.
It’s typically quite light on the wallet to start a business as a sole trader. The licenses and registrations may only be needed for the specific operation or for your specific business or location.
An LLC is more expensive as there is typically a state filing fee.
There may also be some of the following states:
- Annual filing fees
- Franchise taxes
- Registered agent expenses
- Business license costs
- Professional service fees
The lower cost of a sole proprietorship may be appealing to someone just testing out a business concept.
If you’re considering expanding your operation, the additional costs of the LLC might be justified by the added structure.
Taxes
Taxes can seem complicated when comparing business structures, but the basic difference is often smaller than new entrepreneurs expect.
A sole proprietorship usually reports business profit or loss on the owner’s individual tax return.
A single-member LLC is also commonly treated as a disregarded entity for federal income tax purposes unless another tax treatment is elected. This means the business’s income generally flows through to the owner.
LLCs may have additional taxation options depending on their circumstances. For example, eligible businesses may elect corporate tax treatment.
Tax rules vary based on location, income, business activity, and ownership structure. A tax professional can help determine which treatment makes sense for a specific business.
Paperwork and Administration
If simplicity is your main priority, a sole proprietorship usually wins.
There is generally less formation paperwork and fewer ongoing business entity requirements.
An LLC involves more administration.
You may need to:
- File formation documents
- Maintain a registered agent
- Submit annual reports
- Pay state fees
- Keep business finances separate
- Maintain business records
- Follow state-specific LLC requirements
These tasks are usually manageable, especially for a small LLC, but they still require more attention than a basic sole proprietorship.
Business Banking and Finances
Separating personal and business finances is a good practice regardless of the structure you choose.
For an LLC, this separation becomes especially important because the company is intended to function as a separate legal entity.
A dedicated business bank account can make bookkeeping easier. It also gives you a clearer record of business income and expenses.
It may also make your company appear more established when working with clients, vendors, lenders, or payment processors.
Sole proprietors can also use business bank accounts and should consider doing so once regular transactions begin.
Credibility With Customers
Customers do not always care about the legal structure behind a small business. However, an LLC can sometimes make a company appear more established.
Seeing a company name followed by “LLC” can indicate that the owner has formally registered the operation.
This may matter when working with larger companies, signing contracts, seeking financing, or building relationships with suppliers.
A sole proprietorship can still build a strong professional reputation. Good service, clear communication, reliable delivery, and consistent branding often matter more to customers than the business structure itself.
Raising Money and Adding Owners
A sole proprietorship has only one owner.
If you want to bring another person into the business as an owner, you will usually need to change the structure.
An LLC provides more flexibility because it can have multiple members. Ownership percentages and responsibilities can be established through an operating agreement.
This makes an LLC more suitable for businesses that expect to bring in partners or expand ownership later.
However, companies seeking significant outside investment may eventually consider a corporation instead of an LLC.
When a Sole Proprietorship May Be Better
A sole proprietorship may make sense when you are:
- Testing a new business idea
- Working independently
- Running a low-risk operation
- Earning limited revenue
- Providing freelance services
- Trying to minimize startup expenses
- Not ready for additional administration
For example, a freelance writer working alone with limited operating expenses may decide that a sole proprietorship is enough during the early stages.
The structure can always be reconsidered as the business changes.
When an LLC May Be Better
An LLC may make more sense when your business has greater financial or legal exposure.
Consider an LLC if you:
- Sign substantial contracts
- Work directly with many customers
- Hire employees
- Own valuable business assets
- Carry meaningful business debt
- Want stronger separation between personal and business finances
- Plan to add business partners
- Expect the company to grow
An LLC can provide a stronger foundation for entrepreneurs who already know they want to operate a long-term business.
Can You Change From a Sole Proprietorship to an LLC?
Yes. Many entrepreneurs begin as sole proprietors and create an LLC later.
This often happens when revenue increases, operations become more complex, or the owner becomes concerned about liability.
Changing structures may involve registering the LLC, obtaining or updating tax identification information, opening or updating bank accounts, transferring contracts, changing licenses, and notifying customers or vendors.
Planning the transition carefully can reduce disruption.
Don’t Choose Based Only on Taxes
New business owners sometimes assume an LLC automatically creates major tax savings.
That is not necessarily true.
An LLC is a legal business structure. Tax treatment depends on factors such as the number of owners and tax elections made by the business.
The main reason many entrepreneurs create LLCs is legal separation rather than automatic tax reduction.
Before making a decision primarily for tax reasons, discuss your situation with a qualified tax professional.
Think About Your Business Risk
Risk should play a major role in your decision.
Ask yourself what could realistically go wrong.
Could a customer claim your service caused financial damage? Could someone be injured while interacting with your business? Will you borrow money? Will you sign expensive contracts? Will you employ workers?
The greater the potential financial or legal exposure, the more valuable a formal business structure may become.
Business insurance is also important. An LLC should not be viewed as a replacement for appropriate insurance coverage.
Final Thoughts
When comparing Sole Proprietorship vs LLC: What Should You Choose?, there is no single answer that fits every business owner.
A sole proprietorship offers simplicity, low startup costs, and minimal administrative work. It can be suitable for freelancers, independent professionals, and entrepreneurs testing low-risk business ideas.
An LLC requires more paperwork and expense, but it can provide valuable separation between the business and its owner. It may be a better fit for businesses with customers, employees, contracts, assets, partners, or higher financial risk.
Consider where your business is today and where you expect it to be in the future. Choosing the right structure early can make it easier to manage risk, organize finances, and build a stronger foundation for growth.
Because business formation and tax laws vary by state and situation, consider speaking with a qualified attorney or tax professional before making the final decision.