Small Business Guide

Sole Proprietorship vs. Single Member LLC -The Wise Decision

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Becoming a successful entrepreneur is a dream of many at present. Correct incision making is a crucial skill in becoming successful. It will be challenging for upcoming entrepreneurs to decide on some fundamental legal and financial aspects of their business. There are different business structures for you to choose from when building your business. For small businesses, sole proprietorship and single-member LLC are the two top choices. Therefore, it must analyze sole proprietorship vs. single-member LLC to select what is best for your business.

Getting advice from a professional lawyer is crucial in this case, yet it is always better to know your facts. In this article, we will understand sole proprietorship vs. LLC so that you get better know-how.

Sole Proprietorship vs Single Member LLC

Now we will see the difference between sole proprietorship and LLC (single-member) corporate structures.

The basic difference is that the sole proprietorship and the owner are the same in a sole proprietorship. In a single-member limited liability company (LLC), there is a distinction between the business and the owner in tax and legal aspects.

What is a Sole Proprietorship?

Here, it is the sole individual proprietor who owns all the liabilities and assets of its business. All the assets are considered as the property of the owner. One can say that it is really easy to build a sole proprietorship. As it is easy to form, and there is no need for complex documentation, this business type is trendy among startups.

There is no considerable cost to form this business form. There are both sole proprietorship pros and cons.

Advantages of a sole proprietorship

If you want to test run your business idea before establishing an LLC, a sole proprietorship is ideal for forming. It can be considered a low-risk option for entrepreneurs. Advantages are as follows;

  • If the entrepreneur is working on a tight budget, he or she can establish a sole proprietorship without any cost.
  • There is only one owner in a sole proprietorship, and that owner has the sole control and maintenance of the business.
  • The business owner has the ability to control all the income and the profits if it is a sole proprietorship.
  • It is not complex to stop or dissolve a sole proprietorship. You will no longer have the business if you dissolve it. However, it is important to cancel the registrations and licenses of the business.
  • Tax documentation is very simple for sole proprietorships. Have to pay only personal taxes.

Disadvantages of a sole proprietorship

Though it is very easy to establish a sole proprietorship, some advantages come with it too.

When it comes to business liability, the sole owner is unlimitedly liable for all its debts and obligations. This is because the business and owner are considered as one entity. If you cannot pay the creditors’ debts, then the law allows the banks to seize the sole proprietor’s personal assets and personal funds to cover the debts.

Selling stock is not possible for a sole proprietorship. Therefore, getting investments or raising money for the business is a struggle. And also, the banks inquire a lot before passing a loan for a sole proprietorship.

You cannot continue the business as a sole proprietorship when you want to join another business owner. Then it would be best if you went for a general partnership. When it is a general partnership, all income and losses should be reported to US Return of Partnership Income, Form 1065. And also must file individual K-1s for each partner. Consider general partnership vs. LLC pros and cons as well before making a decision.

Can a sole proprietor have employees?

Yes, a sole proprietor can have employees work for the business. In that process, the owner must obtain an Employer Identification Number (EIN) for filing taxes. If the owner hires independent contractors, they do not need to follow this process. The only requirement is to report the independent contractors in the year-end tax returns.

What is a single-member limited liability company (SMLLC)?

Unlike in sole proprietorship, the owner and the business are two separate entities in single or sole member LLC. So, how does an LLC work?

Here, the owners are the investors who are known as members. There can be appointed managers, or the members themselves can manage an LLC. When an LLC has only one such member, we can call it a single-member LLC.

SMLLC also has both pros and cons associated with it. The requirements in establishing an LLC can vary among the different states.

Single member LLC advantages

Compared to a sole proprietorship, single-member LLC is associated with less risk for the business owner. As the name implies, the owner is limitedly liable for debts related to the business.

If the owner has huge personal assets and funds, those are shielded from personal liability if they run a single-member LLC. In bankruptcy or close of business, creditors cannot recover their debts from those personal savings or assets.

In the eyes of the law, the LLC is a separate legal entity responsible for its own actions. The LLC is entering into contracts, obtaining loans, or entering into agreements, not the business owner.

A single-member LLC does not need to pay taxes as a business entity. Income and loss report the file as personal income tax returns. The owner will pay the taxes at an individual level.

A single member can continue upon the owner’s death only if the owner has appointed a representative to take over the LLC. Otherwise, the business will dissolve.

Single member LLC drawbacks

When compared between SMLLC vs. sole proprietorship, establishing a single-member LLC is expensive. The documentation process is complex and must select an applicable, registered state agency. The filing can be considerably expensive and will take more time and effort as well.

SMLLC needs annual state filing.

Sole Proprietorship tax vs. Single Member LLC tax

A sole proprietorship should comply with the federal, state, and local level taxation laws. The sole proprietor has to report their income and loss from the business on the “proprietor’s” personalized income tax.

When it comes to single-member LLC taxes, the IRS takes a single-member LLC as a “disregarded entity.” That means they consider the business owner and the business without any separation between the two.

Therefore, IRS taxes of a single-member LLC tax rate are similar to that of a sole proprietor by default. But, there are different options to change the taxation process or a single-member LLC.

Those are single-member LLC taxed as C corp and S corp. Those options can be beneficial when it comes to LLC taxation.

Can a sole proprietor be an LLC?

It will be a good decision to run your business as a sole proprietorship as a startup or test run a business idea. But as your business grows, you can consider the change of sole proprietorship to LLC. And that is a possible switch. As discussed before, changing from a sole proprietorship to LLC will protect the owner’s personal assets and give more market credibility to the business.

There is a lengthy yet not very complex process to follow when switching between the business structures. But, it will be a worthy decision to make as you grow as a business.

The bottom line

Under the topic, we discussed sole proprietorship vs. single-member LLC in detail. We can realize that there are both advantages and disadvantages in forming, managing, taxation, and many other aspects. Depending on the type of business, experience, and knowledge in business, one can choose between sole proprietorship and SMLLC.

Sole proprietorship comes with more freedom and ease, while SMLLC comes with higher market credibility and protection. Is it not easy to select the right structure on your own? Then do not hesitate to seek advice from a lawyer or a business professional.

Further study…..If you are interested… Credits go to Hawthorn Law’s youtube channel.

DISCLAIMER: The information provided in this article is for informational purposes only and is not meant to take the place of professional legal, accounting, or financial advice. If you have any legal questions about this article or the subjects discussed, or any other legal matter, you should consult with an attorney or tax professional in your jurisdiction (where you live).

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