Is an LLC better than a sole proprietorship?
The question of whether an LLC is better than a sole proprietorship is a complicated one. The truth is, the answer greatly depends on your circumstances. Some businesses may be better off as an LLC while others will be better off as a sole proprietorship. You have to look closely at your circumstances and how you plan to operate your business to determine if you would gain advantages from incorporating. The following break down of the pros and cons of each option should help you gain some perspective so you can make an informed decision.
What are the differences between an LLC and a sole proprietorship?
Probably the most important difference between an LLC and a sole proprietorship is the legal liability you face in each category. In an LLC, if you are sued the other party can only go after the assets of the LLC – not your personal assets (as long as you keep your business and personal assets properly separated). In contrast, if someone sues your sole proprietorship they can go after your personal assets.
There are more things to consider, though, between these two options. Let’s look at some of the pros and cons of each.
LLC pros and cons
Pros of an LLC
- Protection from liability. This is the benefit that most often drives small businesses to form an LLC. As long as you are diligent about keeping your business finances separate from your personal finances – including your assets and your capital – you should be able to maintain the corporate veil so that lawsuits cannot touch your personal assets.
- Your business looks more credible. An LLC just looks more attractive to investors and to customers. It makes you seem more official and respectable, which can bring a lot of benefits over the long-term.
- It is easier to get financing and investment. Most lenders will look at a sole proprietorship with skepticism, as will equity partners. But if you have an LLC, you are going to be treated as an official business institution – which means you are more likely to be cleared for loans and investments.
- You gain options to customise how you are taxed. As an LLC, you can decide to be taxed as a sole proprietorship, or you can choose other taxation arrangements like those used by S-Corporations and C-Corporations. There are advantages and disadvantages to each, so be sure to talk to your accountant before making a final decision.
Cons of an LLC
- More paperwork is involved. Many states require you to complete additional paperwork as an LLC.
- It costs more to get your tax returns done. Completing a tax return for an LLC is more complicated than it is for a sole proprietorship – which is why tax professionals charge a premium for the service.
- You will likely have to file annually with your state. LLCs usually have to file annually and pay the fees that are required for those filings.
- You might have to pay state business taxes. Many states require LLCs to pay state business taxes in addition to the other taxes that you have to pay like federal taxes, state taxes, local taxes and FICA taxes.
Pros of a sole proprietorship
- No special paperwork to fill out. Usually, the only thing you have to do to establish a sole proprietorship is to start working on your business. States don’t require you to fill out special paperwork – unless you happen to need certain licenses for your business.
- Your taxes are simpler. All of the money you spend and the money you make goes through your personal accounts. Your tax burdens are all based on your personal situation and are therefore simpler to fill out. You don’t have to pay any business taxes, either.
- You get to take tax deductions for certain business expenses. LLCs also get to deduct certain business expenses from their taxes, but you don’t have to incorporate to take advantage of this tax arrangement. You can even convert some of your personal expenses into business expenses as long as you can show that they were for your business and not for your personal use.
- You do not have to file annually. Unlike with an LLC, you do not have to file annually with your state and pay the associated fees for your filings. However, you may have to keep up with certain industry filings if they apply to your business.
Cons of a sole proprietorship
- You could be liable for commercial debts. If your business is sued and you lose the lawsuit, they could come after your personal assets. Things like your savings accounts, family home and automobiles could all be at risk if you find yourself in such a situation.
- It is harder to get a business credit score. When you are an LLC, you will begin to establish a credit score based on your business credit. But as a sole proprietorship, you will have a harder time being seen as a business and getting business credit.
- It may be more difficult to get business loans. Most lenders will look at a loan to a sole proprietorship as a personal loan. Personal loans are usually smaller, so you may struggle to get a big enough loan to achieve your goals if you are a sole proprietorship.
- You will have less credibility. An LLC looks more official than a sole proprietorship. If you are trying to get your name out there to clients, customers and lenders, you are likely to be less impressive if you are a sole proprietorship instead of an LLC.
Which should you choose?
To decide which is best for your business, you will need to consider what advantages and disadvantages you want to take on. If you are worried about liability, an LLC makes the most sense. But if you want to keep things as simple as possible, it will probably be easier to stick to a sole proprietorship. In the end, the choice is up to you.