LLC vs. Sole Proprietorship: Which Structure Should You Choose?

In many cases, this decision can influence your long-term success as a business owner. Most small business owners and entrepreneurs choose between two common options: a Limited Liability Company (LLC) or a Sole Proprietorship. Each structure has its own advantages and drawbacks. This guide explains both options in detail to help you determine which structure best fits your business goals.

What Is a Sole Proprietorship?

A sole proprietorship is the simplest form of business ownership. If you start a business on your own and do not formally register a separate business entity with the state, you are automatically operating as a sole proprietorship.

Sole proprietorships do not require state-level formation documents. The business income passes directly to the owner and is reported on the owner's personal tax return using Schedule C, similar to how a single-member LLC is taxed.

The major drawback of a sole proprietorship is that it does not provide personal liability protection. Legally, the business and the owner are considered the same entity. This means that if the business incurs debt, faces legal claims, or is sued, the owner is personally responsible.

As a result, personal assets such as savings, vehicles, and even a home may be at risk if the business cannot meet its obligations.

Business Name and DBA

By default, a sole proprietorship operates under the owner's legal name. However, if you want to use a different business name, you must register a DBA (Doing Business As) name.

A DBA, also called a fictitious name or trade name, allows a business to operate under a name other than the owner's legal name. For example, if "Jane Smith" owns a business called "Jane's T-Shirts" and later wants to sell shoes under the name "Jane's Shoes," she would need to file a DBA.

Important points about a DBA:

• It does not create a legal entity
• It does not affect taxes
• It only allows the use of an alternate business name

In most states, DBAs are filed at the county or municipal level, although some states require state-level registration.

What Is an LLC?

A Limited Liability Company (LLC) is a popular business structure that combines simplicity with legal protection. LLCs are formed by filing Articles of Organization with the state and paying a required formation fee.

One of the biggest advantages of an LLC is personal liability protection. If the business is sued or unable to pay its debts, the personal assets of the owners (called members) are generally protected.

Taxation and Flexibility

LLCs are considered pass-through entities, meaning the business itself does not pay federal income taxes. Instead, profits and losses pass through to the members and are reported on their individual tax returns.

LLCs are highly flexible when it comes to both management and taxation. Members can:

• Choose how the LLC is managed
• Decide whether the LLC is taxed as a sole proprietorship, partnership, or corporation
• Elect C-Corp or S-Corp tax treatment if it makes financial sense

Forming a Sole Proprietorship vs. Forming an LLC

Forming a Sole Proprietorship

Starting a sole proprietorship is straightforward and inexpensive. In most cases, you simply begin doing business.

However, it is still important to:

• Check state and local requirements
• Obtain any required licenses or permits

Forming an LLC

To form an LLC, you must file Articles of Organization with your state. These documents are usually submitted online and typically cost around $100, though fees vary by state.

You will need the following information:

• Your LLC's legal name or DBA
• Name and address of the registered agent
• Names of the LLC's owners (members)

What Is a Registered Agent?

A registered agent is an individual or service authorized to receive legal and official documents on behalf of the LLC.

General requirements include:

• Being at least 18 years old
• Having a physical address in the state
• Being available during regular business hours

Registered Agent Services

Many business owners hire registered agent services because they:

• Ensure important documents are handled promptly
• Provide privacy
• Allow owners to focus on running the business

Using a service also prevents business owners from being served with legal documents in front of customers or employees.

LLC vs. Sole Proprietorship: Tax Comparison

Both sole proprietorships and LLCs are pass-through entities, meaning the business itself does not pay income taxes.

LLCs offer additional tax flexibility:

• Single-member LLCs are taxed like sole proprietorships
• Multi-member LLCs are taxed as partnerships
• LLCs can elect corporate taxation

LLC members who are taxed as sole proprietors or partners are subject to self-employment tax. However, if the LLC elects S-Corp or C-Corp status, self-employment taxes may be reduced or eliminated.

LLC vs. Sole Proprietorship: Management Comparison

Sole Proprietorship Management

In a sole proprietorship, the owner has full control over all aspects of the business. The owner:

• Manages daily operations
• Hires and fires employees
• Accepts debt
• Makes all business decisions

LLC Management

Single-member LLCs operate similarly to sole proprietorships. However, multi-member LLCs require a more structured approach.

LLCs can be:

• Member-managed, where all members participate in operations
• Manager-managed, where selected managers handle daily operations

Operating Agreement

Multi-member LLCs should have an operating agreement, even if it is not required by state law. This internal document defines how the LLC operates and helps prevent disputes.

An operating agreement typically includes:

• Ownership percentages
• Profit and loss distribution
• Member rights and responsibilities
• Voting procedures
• Rules for meetings
• Procedures for member exit or death
• Dispute resolution methods

LLC vs. Sole Proprietorship: Liability Comparison

The most significant difference between these two structures is liability protection.

• LLC: Personal assets are generally protected from business debts and lawsuits
• Sole Proprietorship: The owner is personally liable for all business obligations

Legal Requirements and Ongoing Compliance

Sole Proprietorship

Sole proprietorships have minimal compliance requirements. Owners generally need to:

• File annual tax returns
• Renew required licenses and permits

LLC

LLCs involve more paperwork and ongoing obligations, including:

• Filing Articles of Organization
• Submitting annual or biennial reports (in some states)
• Maintaining an operating agreement
• Filing dissolution paperwork if the business closes

Which Structure Is Right for Your Business?

Many entrepreneurs begin as sole proprietors because it is easy and inexpensive. However, the lack of liability protection can create serious financial risk.

For this reason, many startups choose to form an LLC. While it requires more time and money upfront, an LLC provides personal asset protection, tax flexibility, and greater long-term security.

How to Change a Sole Proprietorship into an LLC

Converting a sole proprietorship into an LLC involves forming a new LLC entity. You will need to:

• Choose a unique business name
• File Articles of Organization with your state
• Designate a registered agent
• Obtain a new EIN from the IRS
• Update licenses and permits
• Open a new business bank account
• Notify clients, vendors, and tax authorities