By Heather Huston, Assistant Service Manager, BizFilings
Before starting a new, solely owned business, it is important to understand the pros and cons of two popular business structures: the limited liability company (LLC) and the sole proprietorship.
To make the best decision, you should carefully consider your choice of business entity from multiple angles, including ownership and control of the business, asset protection, and tax implications.
As you begin evaluating, remember to -
One of the most common types of small businesses in the U.S. is a single-owner or single-member LLC. This is a business entity registered in the state of formation, which usually will be where the company does business.
The term single-member is used to recognize that the LLC has one owner, as opposed to an LLC in which there is more than one owner. A single-member LLC has all the same advantages—and disadvantages—of a multi-member limited liability company.
Each state has different requirements for forming an LLC.
Note that you can form your LLC in a different state than where you do business. Each state other than where you initially formed your LLC is a “foreign” state. You are required to foreign qualify in those states in order to do business there. This generally requires filing an application for authority with that state’s business entity filing office.
There are many benefits to forming an LLC versus operating as a sole proprietorship. A single-member LLC is generally shielded from personal liability for debts associated with the business.
Note: Single-member LLCs must be careful to avoid commingling business and personal assets. This could lead to what is called piercing the corporate veil and the loss of your limited liability.
According to the IRS, a single-member limited liability company is a "disregarded entity", meaning there is no separation between the business and its owner. By default, the IRS taxes it the same as a sole proprietorship.
However, you do have the option to be taxed differently.
As with a sole proprietorship, the business’ income tax obligations automatically fall to the LLC owner. If you want to elect another tax route, single-member LLC owners can choose to be taxed as a C corporation or S corporation. This is something you can’t do if you elect to do business as a sole proprietorship.
Other benefits of forming a single-member LLC include the following:
Ultimately, LLCs can have limited life if you don’t prepare ahead of time. In many states if an LLC has no members, for example, if the only member dies, the LLC will have to be dissolved. Statutes allow the single-member LLC to continue by providing for it in the operating agreement, for example, naming a representative to take over. The fact it can continue if the owner dies can be considered an advantage of an LLC over a sole proprietorship.
While there are many good reasons to choose a single-member LLC for your business, there are disadvantages to be aware of as well. The first of these is cost. An LLC is subject to state formation fees, as well as ongoing fees such as annual report fees and franchise taxes.
Before you file the documents to form your LLC, you’ll need to select a registered agent located in the state. This person—which can be a corporate service company—receives legal papers on your behalf, which is specifically beneficial in the case of a lawsuit or legal issue. The registered agent’s name and address must be included in the formation document.
There are additional requirements for a single-member LLC, including, but not limited to the following:
Finally, be aware that inadvertent administrative dissolution can happen easily if you’re not clear on the laws regarding your LLC duties. For example, if you thought that because you didn’t have to pay state income tax, you don’t have to pay franchise taxes either, and you fail to pay the franchise taxes, your LLC could be dissolved.
Sole proprietorships are the most basic form of business structure. If you don’t form a business entity, like an LLC or corporation, but start conducting business, you're automatically considered a sole proprietorship. This means your business is not an entity separate and apart from its owner and your business’s assets and liabilities are not separate from your personal assets and liabilities. This means you can be held personally liable for the debts and obligations of the business, which is one of the main differentiators from an LLC.
Sole proprietorships are ideal for low-risk businesses and entrepreneurs who want to test their business idea before pursuing a formal entity formation option. As such, there are many advantages.
It’s important to consider the disadvantages of a sole proprietorship. While the financial savings are appealing, there are drawbacks to this business structure.
A single-member LLC has its advantages, as does a sole proprietorship. There are many similarities between the options as well, from paperwork to tax requirements. Get all the facts before making your choice.
There are important differences between LLCs and sole proprietorships. The most significant difference is whether you have limited liability for the business’ debts and obligations, as with an LLC, or whether the business’ liabilities and obligations fall to you personally in the event of a lawsuit or debt collection.
An LLC has distinct advantages in the areas of legal protection and liability. While there are filing fees for setting up an LLC, that cost can be well worth it when compared to the thousands of dollars you could be liable for as a sole proprietor.
On the other hand, it costs no money to start a sole proprietorship. You can also transition into an LLC or other formation option whenever you’re ready. This also means dissolving your business is as simple as stopping operations (and canceling any licenses and permits).
Finally, while sole proprietorships have very little regulatory requirements, LLCs are associated with a variety of fees and filings, both initially and ongoing. This can be difficult to manage on your own, which can lead to missing important filings and, in return, incurring penalties.
When deciding between a single-member LLC and sole-proprietorship, focus on the needs of your business. As an entrepreneur testing the waters, a sole proprietorship may be an easy and cost-effective option, while a fast-growing business that needs funding would be better suited to an LLC. Consider your business objectives when reviewing your options, from financial to operational, to make the best choice for you and your business.
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