You need to make many decisions when starting a small business. One of the most important is how you structure your business legally. There are different ways to structure a business--partnerships, S-corporations, C-corporations, limited liability corporations, and sole proprietors to name a few. The two most popular business entities for small businesses are the Limited Liability Corporation (LLC) and Sole Proprietorship. These two types of businesses have similarities and differences. It is important to know how they compare so that you can make the best decision for your business needs. Some of the main differences are in taxation and handling financial obligations. Be sure to perform due diligence before making a decision. Get help by consulting with a trusted tax attorney, business consultant, and/or financial planner when obtaining the information you need to make the best decision for you and your business. The Doyle Law Offices are here to help guide you through this important process, whether you decide to incorporate your business or not.
Sole ProprietorshipA Sole Proprietorship is the easiest and most cost-effective type of business to form and operate. There is no charge to set up a sole proprietorship and you can name the business whatever you want. Generally, sole proprietors own small or part-time businesses with no employees, but this is not a requirement. With a sole proprietorship, the business entity and the owner are the same. A business can have only one person acting as the company’s owner in order to be treated as a sole proprietorship. No other business, trust, or estate can participate in ownership; therefore, sole proprietors have full control over the business. The sole proprietor makes all the decisions about the operation of the company and the use of the company’s resources. A sole proprietor reports net income or loss from a business on the proprietor’s (owner’s) personal income tax.
Unlimited liabilitySole proprietors have unlimited liability for business debts, lawsuits and other business-related obligations. This means they are held personally liable for all debts incurred by the business. Because a sole proprietor is liable for the business’s debts, creditors can go after a home, car, and other personal property in satisfying the debts. If the assets of a sole proprietorship are not enough to meet the business’s debts, then creditors can target the owner’s personal assets to satisfy the debts.
Taxes for a Sole ProprietorshipA sole proprietor reports net income or loss from a business on his/her personal income tax. The IRS calls this “pass-through” taxation because the business profits and/or losses pass through to be taxed on the owner’s personal tax return.
Advantages and Disadvantages For a Sole ProprietorshipAdvantages:
- Easy, simple to set up - no cost
- Pass-through taxation - no corporate tax return and no double taxation
- Unlimited liability - owner is completely responsible for debts and liabilities of the business
- No business write-offs
- Can be difficult to get business loans or lines of credit
Limited Liability CorporationA Limited Liability Corporation (LLC) is its own legal entity and separate from the owner and has distinct advantages in the areas of legal protection and liability. An LLC is really a blend of a business partnership and a corporation. It has separate debts and assets apart from the owner’s personal assets, except for the owner’s taxes. An LLC can be owned by investors who are called “members.” These members can manage the business themselves, or by designated managers. A key benefit of an LLC is that a member’s liability is limited to the amount of his or her investment in the company. Typically, on average an LLC costs $1,000 to set up. The cost is definitely worth it as compared to the thousands of dollars you can be liable for if you are a sole proprietor.
Limited LiabilityThe term “limited liability” indicates that the business owner(s) is protected from lawsuits, debtors, and other financial obligations related to the operation of the LLC. By setting up the business as an LLC, the owner protects him or herself from creditors and legal trouble.
Taxes For an LLCThere is flexibility in handling taxes with an LLC. An LLC is not a separate tax entity like a corporation but it can make an election to be taxed as a corporation. If such an election is not made, it is taxed as either a sole proprietorship or a partnership and deemed a “pass through” entity (like a sole proprietorship). All of the profits and losses of the LLC pass through the business to the LLC members who report this information on their personal tax returns. The LLC itself does not pay federal income taxes, although some states impose an annual tax on LLCs.
Advantages and Disadvantages For an LLCAdvantages:
- Liability protection - owners are protected from the debts and liabilities of the business
- Flexible management
- Pass-through taxation
- Flexibility in ability to allocate profits and losses to members in varying amounts
- Subject to self-employment taxation
- More paperwork and fees than a sole proprietorship
- Separate records - must keep business records and personal records separate
- Unemployment compensation - the member(s) may have to pay