Getting ready to start an ecommerce business? Your store launch checklist is likely packed with fun things like finalizing your logo and branding, sourcing the perfect products, and building out your marketing plan. And while starting your own business is certainly exciting, it often requires some not-so-exciting decisions, like choosing your business structure.
One of those business structure decisions could be whether to launch as a sole proprietorship or an LLC. It’s important to understand the differences between the two, because the decision could impact your tax reporting and compliance obligations.
In this post, we undertake a sole proprietorship versus LLC comparison to help you determine which business type is right for you as a new business owner.
Table of contents
- What is a sole proprietorship?
- What is an LLC?
- Sole proprietorship vs. LLC: how they stack up
- Core differences between sole proprietorship and LLC
- Move forward with your new business
What is a sole proprietorship?
A sole proprietorship, or sole prop, is the most basic type of business. This structure is an unincorporated business owned by a single individual, with no legal separation between entity and owner.
If you own a sole prop, you have total control over the business and all of its income. Your business profit is taxed just like personal income, and you can do whatever you want with what’s left over. Many other business structures have multiple owners who share control and have to agree on how you allocate income.
A sole prop has less protection for your personal assets than most other business structures, namely personal liability protection. Owners assume complete legal responsibility for the business’s losses and liabilities. Other business structures, like LLCs, legally separate the person and the business as separate entities—which limits personal liability. For example, if you have business debts with an LLC, you’re shielded from a lawsuit coming after your personal assets.
Creating and operating a sole prop is a relatively simple process, which makes it a popular choice among the self-employed, like freelancers or small business startups. You might have even done this at some point without realizing it.
Anyone who turns a profit while working independently is considered a sole proprietor by default. So if you’ve ever received payment for a service you provided on your own—not under the scope of another employer—you were operating as a sole prop. There’s no formal registration or filing process required to establish this status. Compared to other business structures, a sole prop is easy to establish and maintain—which makes it a common choice for entrepreneurs and online merchants with low-risk businesses—like print on demand, for instance.
Pro tip: Laws vary by state and nature of business. It’s always best to check with your local jurisdictions to find out what the requirements are for setting up your sole proprietorship, as well as noting necessary tax filings, licenses or permits.
Benefits of sole proprietorships
A sole prop is a popular business structure for new businesses and entrepreneurs because it offers the following advantages compared to LLCs:
- Simplicity. It’s relatively easy and inexpensive to establish. If you’re the only owner and employee performing your business activities, then you’ve already formed your own sole prop. Establishing other business structures, like an LLC, requires paperwork and processing.
- Income tax filing considerations. The owner and business are considered the same entity and generally will only have to file one federal income tax return and one state income tax return (per jurisdiction)—so income is only taxed once. Single-member LLCs could offer this same advantage If a second owner joins the businesses, the sole proprietorship will then be required to file partnership tax returns.
- Fewer guidelines. Sole props have fewer regulatory requirements than other business structures. LLCs require a formal registration process; including a separate and uniquebusiness name and registering an agent to correspond on behalf of the company. Many states charge filing fees for LLCs.
Drawbacks of sole proprietorships
A sole prop might not always be the best choice, depending on your business type and goals. Here are some disadvantages compared to LLCs:
- Personal liability. The owner is responsible for all debts or losses incurred by the business, including lawsuits.
- Difficulty raising capital. Banks and investors are generally less likely to provide financial support for sole proprietorships in comparison to LLCs because it’s a less “formal” business entity.
- Everything is on you. Without partners or investors, entrepreneurs are on their own when it comes to making business decisions in a sole prop. Owning and running your own businesscan be isolating at times.
What is an LLC?
An LLC, or limited liability company, is a structure that combines characteristics of a corporation and a sole proprietorship. There are many types of LLCs, each with different parameters. The single-member limited liability company is most comparable to a sole proprietorship, and what we’ll be comparing in this post. A single-member LLC consists of just one owner, who controls 100% of the business.
LLCs are popular because of their flexibility and protection. For many, it’s the next step after launching as a sole prop. An LLC is recognized as a legally separate entity and business structure, protecting your personal liability as the owner.
While this personal-business separation is beneficial from a liability standpoint, single-member LLCs are generally treated as “disregarded entities.” This means, as with a sole proprietorship, the business’s income tax obligations “flow through” to the owner and are filed in conjunction with the sole owner’s personal income tax filings.
LLCs are formed in the state in which they operate, which can add to the complexity and cost of setting up and maintaining it. But overall, the process is relatively simple and affordable, though less so compared to sole proprietorships.
Benefits of LLCs
Single-member LLCs have a few benefits over sole proprietorships, in particular:
- Personal protection. While a sole prop puts your personal assets at risk with zero liability protection, an LLC legally separates the business entity from the person. So your personal assets have more protection and can’t necessarily be seized for company debts. There is still some risk, an LLC does provide significantly more personal liability protection compared to the standard sole proprietorship.
- Simple setup. Single-member LLCs require more setup than sole props, but the process is still straightforward and has fewer steps than other corporate structures. You file your articles of incorporation with the state and then it’s done.
- Income tax flexibility. With a single-member LLC, you can choose to be taxed like a sole prop or elect to be taxed as an S corporation or as a C corporation for income tax purposes. While S corporations could offer some of the pass-through taxation benefits enjoyed by LLCs and sole props, they have very specific requirements (both in terms of eligibility and tax filings). Business owners should consult with a licensed tax adviser to determine the best structure. It’s always best to consult your own tax adviser.
Drawbacks of LLCs
While limited liability companies have many advantages of sole proprietorships, there are some downsides to consider:
- Dealing with the state. When you have an LLC, you have to manage your business with the federal and state governments, and possibly more local jurisdictions, depending on the nature of your business. Sole proprietors don’t have to deal with state-level licensing, bureaucracy, and admin unless they’re in a qualifying industry.
- Cost. LLCs have more associated costs than if you choose the sole proprietor route—an important consideration if your budget is tight.
See our state specific guides forCalifornia LLC,Texas LLCandFlorida LLC.
Sole proprietorship vs. LLC: how they stack up
Taxes
Overall, a limited liability company offers more protection in terms of personal liability protection than sole proprietorships—one of the major benefits of this business type.
In an LLC, the owner is only personally liable up to the amount of money they’ve invested in the LLC. So if the LLC has debts, the owner doesn’t risk any personal liability to pay off those debts in case the business is unable to on its own. However, you have to ensure your business and personal dealings are completely separate. Again, it’s always best to consult your tax professional.
With a sole proprietorship, all of your personal assets are at risk if your business finds itself in debt. This is an especially important consideration when making significant investments in your business. Learn more:How to Get a Business License
Liability
Overall, a limited liability company offers more protection in terms of personal liability protection than sole proprietorships—one of the major benefits of this business type.
In an LLC, the owner is only personally liable up to the amount of money they’ve invested in the LLC. So if the LLC has debts, the owner doesn’t risk any personal liability to pay off those debts in case the business is unable to on its own. However, you have to ensure your business and personal dealings are completely separate. Again, it’s always best to consult your tax professional.
With a sole proprietorship, all of your personal assets are at risk if your business finds itself in debt. This is an especially important consideration when making significant investments in your business.
Learn more: How to Get a Business License
Costs
A sole prop can be more affordable to establish than an LLC, since there’s no formal process or paperwork involved. While not required, some sole props may choose to register a doing business as (DBA) trade name. DBA registration costs depend on location. Both sole prop and LLC business owners will also need to check out local business operation regulations and obtain any licenses or permits necessary.
The cost of establishing an LLC depends on the location of the business, as requirements vary by state—so it’s important to research and follow state guidelines. Most states require LLCs to create a separate entity name and register it with the secretary of state.According to the US Small Business Administration, this registration process generally costs less than $300, but can vary depending on location and type of business.
Learn more:How to Register a Business: What You Need to Do
Funding
When it comes to external funding, it’s usually easier for LLCs to raise capital than sole props. From an investment standpoint, an LLC is viewed as more secure than a sole prop, because it’s a recognized separate business entity. These circumstances apply to business loans, business lines of credit, and investors alike.
Many investors are more likely to financially back LLCs because liability is limited to the business, which protects the investor’s personal assets. Sole proprietorships are more limited with financing options from banks too—many banks will only issue personal loans to sole prop owners, which are more restrictive than business loans. An LLC also has the option of bringing on additional partners to invest in the business, whereas sole props can only be owned and operated by one individual.
Management and control
Since sole props must be owned and run by one individual, all the responsibility of business operations and management falls completely on its owner. On the plus side, you have complete control. But it can also limit growth potential—and be a heavy burden to bear alone.
LLCs have more flexibility when it comes to management and control. Single-member LLCs can operate the same way as a sole prop, and they also have the option of bringing on additional members or employees. While the owner still maintains control, they have to balance the needs and wants of others.
Learn more: How to Start An LLC:Everything You Must to Know
Core differences between sole proprietorship and LLC
Here are the highlights of a sole proprietorship versus LLC comparison:
- Taxes. From an income tax standpoint, a sole proprietorship and single-member LLC are generally taxed the same, unless certain elections are made with respect to the single-member LLC.
- Liability. LLCs grant more protections in terms of personal liability.
- Costs. Sole proprietorships are free to start. LLCs require registration and ongoing fees.
- Funding. It’s generally easier to get external financing for an LLC than for a sole prop.
- Management and control. Sole proprietorships offer more control than LLCs, but with that comes more responsibility.
See our state specific guides for California LLC, Texas LLC, and Florida LLC.
Move forward with your new business
Incorporating your business makes it official in the eyes of the government. You’ll protect your personal assets, build credit and history for your company, and even enjoy lower taxes in some cases. But the best benefits of business incorporation are perhaps intangible.
Whether you choose to go the sole proprietorship route or form an LLC, transforming your idea into a real, official business is ultimately up to you.
Ready to create your first business? Start your free trial of Shopify—no credit card required.
DISCLAIMER: These guides are for informational purposes only and do not constitute professional legal or tax advice. Please consult independent legal advice and your own tax advisors for information specific to your country and circumstances. Shopify is not liable to you in any way for your use or reliance on these guides.
Sole proprietorship vs LLC FAQ
What is the biggest difference between a sole proprietorship and LLC?
- Taxes. A single-member LLC can be taxed differently when certain elections are made.
- Liability. LLCs grant more protections in terms of personal liability.
- Costs. Sole proprietorships are free to start, while LLCs require registration and ongoing fees.
- Funding. It’s generally easier to get external financing for an LLC than for a sole proprietorship.
- Management and control. Sole proprietorships offer more control than LLCs.
What are the downsides of an LLC?
- Dealing with government bureaucracy. LLCs are managed with federal, state, and local jurisdictions, so depending on the nature of your business, you may have to deal with licensing and administrative tasks.
- Cost. LLCs have more associated costs than sole proprietorships.
What are the downsides of a sole proprietorship?
- Personal liability. The owner of a sole proprietorship is responsible for all debts and losses incurred by the business.
- Difficulty raising capital. Investors are less likely to support sole proprietorships, because they’re seen as a less “formal” business entity.
FAQs
Is it better tax wise to be sole proprietor or LLC? ›
Which pays less taxes, sole proprietorship or LLC? With both an LLC and a sole proprietorship, the profit of the business passes through to the owner's personal tax return. But LLCs have more flexibility in how they are taxed, which may result in tax savings.
Which is more beneficial LLC or sole proprietorship? ›An LLC has distinct advantages in the areas of legal protection and liability. While there are filing fees for setting up an LLC, that cost can be well worth it when compared to the thousands of dollars you could be liable for as a sole proprietor. On the other hand, it costs no money to start a sole proprietorship.
Why would you choose a sole proprietorship over an LLC? ›A sole proprietorship is the default choice for anyone who runs a business but hasn't set up another formal business structure like an LLC. As a sole proprietor, there's no separation between your personal and business assets and expenses. You are personally responsible for all your business's debts and obligations.
Which is more risky an LLC or a sole proprietorship Why? ›If the business is a sole proprietorship, the owner's home, personal cars, and bank accounts are at risk of being liquidated to pay any resulting judgments. An LLC, on the other hand, takes your personal assets right off the table.
Do you pay more taxes as a sole proprietor? ›Sole proprietors are treated as the same entity as their business for tax purposes. That means sole proprietorships are taxed at the individual tax rate, just like the owner was before starting the business.
How much can you write off as a sole proprietor? ›Qualified Business Income Deduction
In tax years 2018 through 2025, certain sole proprietors can take deductions equal to 20% of their business income, with adjustments.
LLC Disadvantages:
Increased paperwork compared to a sole proprietor including any industry-specific licensing. Annual state filings required. Additional taxes such as a state business tax or unemployment taxes. Costs for forming and completing a tax return for an LLC are higher than those of forming a sole proprietor.
The biggest disadvantage of a sole proprietorship is that this business structure comes with no protection for the business's owner against business-incurred liabilities, such as overwhelming business debt or being sued.
What is the biggest advantage of being a sole proprietor? ›Advantages of a sole proprietorship
Minimal paperwork and low set-up costs are two major benefits of having a sole proprietorship. In addition, there is the ease of maintaining it. In fact, according to the SBA, it's the simplest and least expensive business type you can establish.
- you have unlimited liability for debts as there's no legal distinction between private and business assets.
- your capacity to raise capital is limited.
- all the responsibility for making day-to-day business decisions is yours.
- retaining high-calibre employees can be difficult.
Do sole proprietors need an EIN? ›
Does a small company that operates as a sole proprietorship need an employer identification number (EIN)? A sole proprietor without employees and who doesn't file any excise or pension plan tax returns doesn't need an EIN (but can get one).
What are the disadvantages of a single-member LLC? ›Disadvantages of a Single-Member LLC
A disadvantage of an LLC over sole proprietorships is the amount of paperwork involved. You will also have continued maintenance at both state and federal levels. State laws will give more protection to multiple-member LLCs.
- Cost: An LLC usually costs more to form and maintain than a sole proprietorship or general partnership. States charge an initial formation fee. ...
- Transferable ownership. Ownership in an LLC is often harder to transfer than with a corporation.
Unlimited liability
Among one of the biggest disadvantages of a sole proprietorship is unlimited liability. This liability not only spans the business but the business owner's personal assets. Debt collectors can access your savings, property, cars, and more to see a debt repaid.
A corporation, sometimes called a C corp, is a legal entity that's separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable. Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures.
Can a sole proprietor write off a vehicle? ›The Internal Revenue Service identifies taxpayers who qualify to claim a business vehicle write off as: Self-employed individuals. Sole proprietors and owners of limited liability companies (LLCs) with a tax classification that allows pass-through income on Tax Form 1040 qualify for the write off.
What percentage should I pay myself as a sole proprietor? ›A safe starting point is 30 percent of your net income.
Since they'll know how much you typically earn in personal income, they can give you a more accurate percentage to plan for when it's time to file your income tax return, as well as for making quarterly estimated tax payments in advance.
A sole proprietor will submit a Schedule C with their personal 1040 tax return on an annual basis. They will also be responsible for filing Schedule SE with these returns and paying self-employment taxes on a quarterly basis.
What expense Cannot be deducted by a sole proprietor? ›The IRS recommends treating all your startup costs as capital expenses. While you can deduct interest and taxes in some circumstances, they cannot be deducted as startup costs on your sole proprietorship taxes.
Can I pay myself a salary as a sole proprietor? ›While the business owners can have other employees on payroll who receive wages and salaries from the company, a Sole Proprietor cannot pay themself wages or salaries from which income tax, Social Security tax, or Medicare tax are withheld. Also, Sole Proprietors do not receive a Form W-2 from the Sole Proprietorship.
What business expenses are 100% deductible? ›
- Furniture purchased entirely for office use is 100 percent deductible in the year of purchase.
- Office equipment, such as computers, printers and scanners are 100 percent deductible.
- Business travel and its associated costs, like car rentals, hotels, etc. is 100 percent deductible.
- Easy to form-
- Sole or Individual authority-
- Decision-Making Process-
- Gain total profits of the business-
- Direct relations with customers-
- Flexibility in operations of the business-
- Creation of employment facilities-
- Social benefits-
Sole Proprietorship. Unlike a Sole Proprietor which is an unregistered business entity using for the most part the single owner's name, a Single-Member LLC registers the business entity with the state and separates the personal assets of the single owner from that of the business.
Why is liability the biggest disadvantage of a sole proprietorship? ›The risk of unlimited personal liability can be a major financial burden for a sole proprietor. This is because the sole proprietor's personal assets, such as their home, savings, and other investments, could be used to satisfy a court judgment.
What kind of person is most suited to own a sole proprietorship? ›A sole proprietorship is best suited to small businesses with low risk and low profits. Generally, these businesses don't have a wide range of customers but rather a small, dedicated group. Sole proprietorships often start as hobbies that grow into a business.
Do you need a separate bank account for a sole proprietorship? ›There is no legal requirement for a sole proprietor to have a separate account for business. That being said, we highly recommend not using your personal account for your business. Opening a business bank account is a very small investment that will save you time and money in the long run. You won't regret it.
What is a real life example of a sole proprietorship? ›Examples of sole proprietors include small businesses such as, a local grocery store, a local clothes store, an artist, freelance writer, IT consultant, freelance graphic designer, etc.
What are 3 advantages of starting a sole proprietorship? ›Sole proprietorships are easy to establish and get started. The owner retains complete control of the business. There are no corporate income tax payments. They are less expensive than other business types.
Can I change my EIN from LLC to sole proprietorship? ›Your preparations should include: Getting a new EIN from the IRS. Unfortunately, you can't continue to use your LLC's EIN because the IRS requires all sole proprietors who have purchased or inherited an existing business to obtain a new EIN. As a sole proprietor with no employees, you can choose to use your own SSN.
What is a reason that owning a sole proprietorship business can be risky? ›Unlimited Liability and Risk -The owner of a sole proprietorship is personally responsible for all of the business's debts, which places his or her personal assets and future wages at risk. This is the number one reason to avoid sole proprietorships.
Is a sole proprietor the same thing as being self-employed? ›
Sole proprietors and independent contractors are self-employed individuals who go into business without registering their business as a legal entity such as a corporation, a partnership, or a limited liability company (LLC). A sole proprietorship is a single-person business on any type.
Does a sole proprietor pay self-employment tax? ›Sole proprietor:
If you are a sole proprietor, your business income and expenses should be reported on Schedule C. You'll be responsible for paying self-employment taxes—such as Social Security and Medicare.
Yes. A sole proprietor can open a personal or business bank account and use it for business purposes. While there aren't small business bank accounts that are made specifically for sole proprietors, any small business checking account is open for your consideration.
Does a sole proprietor need to register with IRS? ›In California, you don't have to take special steps to register your business with the California Secretary of State if you operate as a sole proprietorship. You're simply a sole proprietor once you begin doing business – and earning business income.
Does a sole proprietor need a w9? ›Yes. If you are an independent contractor without a business, you will still need to fill out a W-9 as an individual, a sole proprietor, or a single-member LLC.
Should a husband and wife be a single-member LLC? ›If an LLC is owned by a husband and wife in a non-community property state the LLC should file as a partnership. However, in community property states you can have your multi-member (husband and wife owners) and that LLC can get treated as a SMLLC for tax purposes.
Should you pay yourself in single-member LLC? ›Single-member LLCs: Owner's draw
Rather than taking a conventional salary, single-member LLC owners pay themselves through what's known as an owner's draw. The amount and frequency of these draws is up to you, but it's ideal to leave enough funds in the business account to operate and grow the LLC.
For federal income tax purposes, a single-member LLC classified as a disregarded entity generally must use the owner's social security number (SSN) or employer identification number (EIN) for all information returns and reporting related to income tax.
What is the biggest mistake LLC owners make? ›Business owners often make the mistake of not understanding how to properly file their LLC taxes. Since the IRS doesn't recognize LLCs as a tax entity. If you're a single member LLC, you're considered a disregarded entity (same as a sole proprietorship), and you'll need to file a Schedule K.
Why do people prefer LLC? ›The main advantage to an LLC is in the name: limited liability protection. Owners' personal assets can be protected from business debts and lawsuits against the business when an owner uses an LLC to do business. An LLC can have one owner (known as a “member”) or many members.
Why do investors not like LLCs? ›
Typically, venture capitalists (and sometimes angel investors) will not fund LLCs. There are several reasons for this. One is because an LLC is taxed as a partnership (pass-through taxation) and will complicate an investor's personal tax situation.
What is the reason sole proprietors are so popular? ›The sole proprietorship is a popular business form due to its simplicity, ease of setup, and nominal cost. A sole proprietor need only register his or her name and secure local licenses, and the sole proprietor is ready for business.
Why do most sole proprietorships fail? ›There are many reasons why small businesses fail including poor financial planning and lack of market demand. If you are going it alone as a sole proprietor, survival can be even more challenging because you are responsible for literally every aspect of your business.
Why do so many sole proprietorships fail? ›Failure often stems from poor financial management, inadequate analysis of the competition and failure to leverage resources to help compensate for a lack of knowledge on specific business functions, such as marketing or website design.
What is the cheapest form of business ownership? ›Sole proprietorships, for example, are the cheapest and easiest form of business to start.
What is the simplest form of business owned? ›A sole proprietorship is the easiest and simplest form of business ownership. It is owned by one person. There is no distinction between the person and the business.
Can you use an LLC to reduce taxes? ›An LLC can help you avoid double taxation unless you structure the entity as a corporation for tax purposes. Business expenses. LLC members may take tax deductions for legitimate business expenses, including the cost of forming the LLC, on their personal returns.
What are the disadvantages of sole proprietorship? ›- you have unlimited liability for debts as there's no legal distinction between private and business assets.
- your capacity to raise capital is limited.
- all the responsibility for making day-to-day business decisions is yours.
- retaining high-calibre employees can be difficult.
Limited Liability Company (LLC)
For state purposes, an LLC is a business separate from its owner in which the owner is protected from the LLC's acts and debts, such as bankruptcy and lawsuits. For federal tax purposes, an LLC is disregarded as separate from its owner, therefore is liable for taxes.
- 3 disadvantages of sole proprietorship. No liability protection. ...
- No liability protection. ...
- Harder to get financing and business credit. ...
- It's harder to sell your business.
What is the biggest disadvantage of sole proprietorship the proprietor has? ›
The biggest disadvantage of a sole proprietorship is that there is no separation between business assets and personal assets. This means that if anyone sues the business for any reason, they can take away the business owner's cash, car, or even their home.
What is the most tax efficient way to pay yourself? ›The most tax-efficient way to pay yourself as a business owner is a combination of a salary and dividends. This will allow you to deduct the salary from your business's income and pay taxes on it. If you are not paying yourself a salary, you will have to pay taxes on the profit of your business.
What are the tax disadvantages of an LLC? ›A major disadvantage of an LLC is that owners may pay more taxes. When setting up as a pass-through to owners, they are subject to self-employment tax. Self-employment tax ends up higher compared to being taxed as an employee.
How do small businesses avoid paying taxes? ›- Hire Family Members. ...
- Account for Business Losses. ...
- Track Your Travel Expenses. ...
- Consider All Expenses Such as Rent and Utilities. ...
- Hire a Reputable CPA. ...
- Deduct Assets to Charity. ...
- Track Every Receipt With Software. ...
- Fully Utilize Your Retirement Plan Contributions.
Sole Proprietors pay themselves by taking draws from the company's profits. Typically, this is done by writing a business check in the name of the business owner. Or they may take the draw by transferring funds from their business checking account to their personal checking account or withdrawing cash from the company.
Do I need a separate bank account for sole proprietorship? ›There is no legal requirement for a sole proprietor to have a separate account for business. That being said, we highly recommend not using your personal account for your business. Opening a business bank account is a very small investment that will save you time and money in the long run. You won't regret it.
Can the IRS take your house if its under an LLC? ›The IRS can legally seize your single-member limited liability company property to satisfy taxes if you have not filed IRS Form 8832 and have failed to respond to the IRS notice of overdue tax debt. The IRS actually takes property and uses its value to satisfy the amount of the debt.
How many years can a LLC show a loss? ›The IRS will only allow you to claim losses on your business for three out of five tax years. If you don't show that your business is starting to make a profit, then the IRS can prohibit you from claiming your business losses on your taxes.
What triggers IRS audit LLC? ›Failing to report all your income is one of the easiest ways to increase your odds of getting audited. The IRS receives a copy of the tax forms you receive, including Forms 1099, W-2, K-1, and others and compares those amounts with the amounts you include on your tax return.