There are a number of reasons to choose either a sole proprietorship or LLC not the least of which is distinctions in terms of taxation. Your decision in the matter is not final as a Sole Proprietorship can eventually become an LLC.
A sole proprietorship is a simple arrangement where the individual and business are one. The owner is responsible for all debts and assets and there are no distinctions between the entities. The owner is taxed for the business as a part of his or her individual assets. Since the owner has full ownership of the business assets and debts, excessive debts also imperil the personal assets of the owner, as there is not distinction under the law. A sole proprietorship is a good idea for those that do not require financing of immediate capital, do not intend to have many employees, can ensure continuity if the owner is deceased. One should be careful to make distinctions between business and personal assets in this arrangement and organize the two to ensure the protection of personal assets in the event of issues with the business.
An LLC is considered a flow-through entity when the income is not taxed as the income goes directly to the partners who are in turn, taxed on their income. This differs from a sole proprietorship in that the business assets are accounted for separately on an IRS K-1 form, yet still taxed from the owner’s personal income. An LLC benefits the owner by distinguishing business assets, which will give creditors better assurance that sufficient protection is in place to extend lines of credit to the business. A personal guarantee to repay is no longer necessary and LLCs allow for the addition of other partners that can leverage assets and split liabilities to help expand the business. Unlike a sole proprietorship, records of the business must be kept separate from personal finances, which provide better transparency for employees and potential investors.
LLCs can chose their classification for taxation, either as a partnership, corporation or separate entity, each subject to their own taxation laws. In terms of sole proprietorship vs LLC, this is a highly flexible benefit of LLCs, although sole proprietors will have a simplified tax structure as well, only requiring a self-employment tax form.
Sole Proprietorship vs LLC
The decision to choose either a sole proprietorship vs LLC depends on the needs of the owner. Those requiring complex payrolls systems and have a need to expand their business while attracting investment will want the legal legitimacy afforded by an LLC. Those that also seek to add partners and spread liability will certainly need an LLC. Tax benefits increase marginally as more individuals join an LLC and choose the appropriate method of taxation. Those that intend to remain small while avoiding payroll taxes and do not have a need for expansion or investment can remain a sole proprietorship. Those that do so accept the possibility of liabilities extending from the business and the potential for personal assets to mix with business assets.