Sole proprietorship vs. LLC

By Citizens staff

Sole proprietorships and limited liability companies (LLCs) are two popular choices for businesses seeking an easy-to-establish business structure with the right protection and taxation. Evaluating sole proprietorships vs. LLCs can help make it clear how they differ in liability coverage, ownership rules, formation requirements and taxes. Check with legal, tax and financial advisors before making a final business structure determination.

Sole proprietorship

A sole proprietorship is quick and affordable to form and is popular with freelancers, consultants and small retailers. Only one single owner is allowed in a sole proprietorship, and that individual is considered self-employed. Without the creation of a separate legal entity, such as a corporation, the owner and the sole proprietorship are the same. This means that in the case of a lawsuit or debt, creditors can pursue a sole proprietor’s personal assets, such as a house, car, cash or investments. Since the company and owner are one, profits and losses are reported on a personal tax return rather than on a separate business tax return. This is called “pass-through” taxation.

To establish a sole proprietorship, a business owner can simply start conducting business, but it may make sense to first set up a dedicated business banking account to build business credibility, keep your business and personal finances separate, and streamline financial management. Sole proprietors in some industries will be required to obtain licenses and permits to operate, and businesses with employees need an Employer Identification Number (EIN).

To help with marketing, some sole proprietors choose to establish a distinct business name using a “doing business as” (DBA). For example, an interior designer could operate as “Sophisticated Interiors,” or a website designer as “Dynamic Web Design.” A DBA does not establish a business entity, just an alternate name. Depending on local and state rules, a DBA might involve additional fees and paperwork and be required to obtain a business bank account.

LLC (limited liability company)

Unlike a sole proprietorship, an LLC is a separate legal entity, like an S or C corporation, that shields an owner’s assets from debts and lawsuits and puts a layer of protection between creditors and personal assets like a car or house. LLCs may be run by multiple people, companies or other entities, called “members,” unlike sole proprietorships which may only have one owner. These members can have varying degrees of involvement in the LLC, from full operational roles to simply investing. LLCs are allowed to sell equity to members — often called interests or units — but may not issue stock.

LLCs also have more taxation options than sole proprietorships. An LLC can be set up to be taxed like a sole proprietor, in which profits and losses are passed through and reported on owners’ personal tax returns. But LLCs can also elect to be taxed as a corporation or designate different types of taxation for various members.

Forming an LLC requires choosing a name and confirming with the Secretary of State’s office that it is not already in use. If you have a DBA name already, you may use this as your LLC name as long as it is available. LLC formation also requires the help of a registered agent to receive documentation and the creation and filing of articles of organization in your state of operation. LLCs must also obtain an Employer Identification Number (EIN).

Many LLCs create an operating agreement to stipulate how members will make decisions, share assets, handle liability and otherwise manage the business. While most states don’t require an operating agreement to start an LLC, creating one is a good practice to define your business structure for all stakeholders. Some state guidelines stipulate how LLCs must be established and governed, so check with local and state guidelines.

Pros and cons of sole proprietorships and LLCs

Any business structure has pros and cons. Understanding the benefits and limitations of sole proprietorships and LLCs can help to inform your choice.

Sole proprietorship pros

• Quick and easy to form.
• Profits and losses flow through to the owner’s personal income tax return, meaning no extra business tax returns are typically required.
• Single owner means decision-making and operational choices do not require building consensus with others.
• Easy to shut down. Dissolution of a sole proprietorship may only require filing a Form 4797 if any assets are sold and cancelling of permits, licenses or DBA.

Sole proprietorship cons

• Restricted to one owner only.
• A sole proprietor may be held personally liable both legally and financially for the business’s debts and obligations.
• Because a sole proprietorship isn’t a separate legal entity from the owner, it cannot raise capital by selling equity.
• The entire burden of decision-making is on the owner.

LLC pros

• May have multiple owners, called members, including individuals or business entities.
• Creates a separate legal entity from the owner, which limits personal liability in the event of a lawsuit or debt.
• Provides tax flexibility, since profits and losses can flow through to owners/members or be taxed at the LLC level.
• Offers flexibility in ownership because owners/members can have varying degrees of operational and decision-making responsibility.
• Can issue shares to raise capital, although cannot issue stock.

LLC cons

• Establishing an LLC requires filing paperwork, paying fees and establishing operational guidelines (recommended but not required in most states).
• Ongoing filing and compliance requirements take time and money.
• Banks and insurance companies are not allowed to be LLCs, and some states have additional LLC restrictions.
• Shutting down requires an agreement by members, the filing of articles of dissolution with the state, and other steps.
• Decision-making may require building consensus among members with business operation responsibilities.

Sole proprietorships and LLCs are both easy to establish and straightforward to operate. The best choice between the two depends on ownership, liability and taxation priorities. Whichever business structure you choose, be sure to create a strong financial foundation by establishing a business checking account. A business checking account can contribute to business credibility, keep business and personal finances separate, and streamline financial management. Look for an account that offers mobile banking, overdraft protection, and invoicing and accounting tools.

Discover how a business checking account can support the success of a sole proprietorship, an LLC or any type of small business.

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When forming any type of business, a business checking account is an essential first step to deposit, move and borrow money for your business. With a Citizens business checking account, you’ll have all of the features you need to manage your business’s finances.

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