Selecting the best structure for your business when starting a new business is vital. Depending on factors like start-up expenses, liability insurance, and tax implications, you might choose between sole proprietorship or LLC. That said, we’ll compare sole proprietorship vs. LLC with relation to taxes, their pros and cons, and how they work for an online business, especially in California.
Sole Proprietorship vs. LLC: General Overview
What Is A Sole Proprietorship?
A sole proprietorship is a one-person business owned by one person who manages the business. You are not a separate legal and tax entity from your business. You are the company.
In a sole proprietorship, you own the assets owned by the industry and the debts, revenue, and obligations. When you file your taxes, you pay taxes on your business profits, and these profits are reflected on your income tax return. Unless you use a trading name, commonly known as “doing business as” or a DBA, your business name will be your name by default.
If you own a sole proprietorship, you’ll be referred to as a “sole proprietor.” In most cases, you don’t have to do anything to establish a sole proprietorship; it just happens when you make your first commercial transaction. Some states, towns, or counties may require you to obtain a business license or permit, but this does not indicate whether you are a sole owner.
What is an LLC?
Whereas a sole proprietorship combines everything between the person and the business, an LLC creates a legal barrier between the two. The LLC is a separate legal entity. What the LLC owns and owes is owned and owed by the LLC, not you.
This is a compelling solution for anyone wishing to safeguard their possessions. An LLC can be held by a single person (referred to as a member), but it can also have multiple owners.
Sole Proprietorship Vs. LLC: Pros and Cons
It’s essential to understand the pros and cons of running a sole proprietorship vs. an LLC.
Consider the following aspects when deciding which structure is best for your company.
#1. Complexity
The sole proprietorship is the most basic sort of business to establish. When forming it, there is significantly less paperwork. You actually only need to start doing business and make sure you have all of the necessary licenses and permits.
However, before conducting business, the LLC must complete a few further processes. Choosing a name for your firm, employing a registered agent, submitting the Articles of Organization (and paying a filing fee), preparing an Operating Agreement, obtaining an EIN, and obtaining insurance are some of these stages.
#2. Cost
Aside from the payments required for licensing and permissions, forming a sole proprietorship is free because no other charges are involved. There are no official ongoing obligations for this type of corporate structure, not even a written agreement.
Having said that, any business needs money to get started. A sole proprietorship requires you to support your own business using loans or your own assets. And obtaining a loan for a sole proprietorship may be difficult since many financial institutions are reticent to lend to a sole proprietorship rather than an LLC, partnership, or corporation. Sole proprietors are frequently required to personally guarantee a loan issued to the business, which may result in personal liability if the business is sued.
An LLC can raise money in other ways, such as by adding new members who can contribute their own capital contributions and by creating new classes of membership interests.
#3. Taxes
All business profits are taxed for a sole proprietor. As a result, the earnings are passed on to the owner. However, because such businesses are considered disregarded by the IRS, a single-member LLC may likewise be taxed in this manner. As a result, if the single-member LLC does not adopt corporate taxation, it will be classified as a sole proprietorship. While such taxes are passed on to the owners of sole proprietorships and single-member LLCs, such owners might still benefit from company tax deductions.
Furthermore, both business models may be eligible for a pass-through deduction of up to 20% of total business income. This is a new deduction that became effective in 2018 as a result of the Tax Cuts and Jobs Act.
You will be taxed as self-employed if you run a sole proprietorship. This means that your business money is considered personal income. A limited liability company, on the other hand, can be taxed as a single proprietorship, partnership, or corporation. However, the LLC must make the decision. As previously stated, if you do not make the election, you risk being regarded as a sole proprietorship (single-member LLC) or a partnership (multi-member LLC).
Sole Proprietorship vs. LLC: Pros and Cons In A Nutshell
Pros of LLC
For people who do not wish to combine work and personal, the words “limited liability” can be highly enticing.
Furthermore, companies that form an LLC may be perceived as more professional by investors and possible business partners. In comparison to some other more intricate business arrangements, forming an LLC isn’t that difficult.
Cons of LLC
For individuals who don’t have extra money to spend, incorporating an LLC may put a strain on their finances. That’s not to suggest it doesn’t have value; nevertheless, a single-person business that isn’t earning much profit may find it difficult to justify the expenditure. In addition, most states require LLCs to pay an annual or biannual fee to keep their LLC registration.
There’s also the issue of paperwork, which must be filed to form the LLC and kept up to date every year or two to keep it active. If you dislike administrative tasks, you can pay someone for them.
Pros of Sole Proprietorship
A sole proprietorship is the simplest form of business. Anyone can establish one simply by doing business. Personal returns can be used to file taxes, with earnings reported on Schedule C.
Cons of Sole Proprietorship
What it lacks in protection, it makes up for in simplicity. Because you are your firm, whether it is involved in a lawsuit or goes heavily in debt, it is your responsibility to resolve the situation.
This isn’t the best case for those who need to separate their work and personal funds, such as when owning assets or applying for loans. In some states, it is likewise restricted to a single owner (or a partnership of spouses). If you wish to bring in partners, you’ll have to give up your sole proprietorship status.
Sole Proprietorship Vs LLC: How Are Theirs Taxes Levied?
The disparity between sole proprietorship vs. an LLC has nothing to do with taxes. Even if you form an LLC, you’ll still be taxed as a sole proprietorship, with profits passing through to the owners’ income. For single-member LLCs, this is the default tax status.
If your LLC has numerous owners, you will each pay taxes based on your ownership portion. The legal separation of an LLC from its owner does not affect your tax situation.
The most significant tax distinction between a sole proprietorship and an LLC is that an LLC provides tax flexibility. That is, you can ask to be taxed as an S Corp, or a C Corp.
Sole Proprietorship Vs. LLC: Online Business
So, you’ve chosen to open an online retail store. You’re figuring out site design, marketing, search engine optimization, money, customer support, shipping, production, and other things. You must also choose a legal structure for your company. As an individual, you can operate as a sole proprietor or as a limited liability corporation. If you have another member/manager in your internet business (even if it is your spouse), you must register an LLC.
Sole Proprietorship vs. LLC Online Business Startup
A sole proprietorship is the most basic business form because you do not need to register your company name with the state and can use your Social Security number instead of acquiring an employer identification number. If you form an LLC, you must first draft an operating agreement if you have more than one member.
Then you must register with your Secretary of State’s office online, pay a fee, and file introductory paperwork known as the articles of organization. For a single-member LLC, you may also need to file for a federal and state employer identification number, or you may be able to operate using your Social Security number. Investigate your state’s regulations on the website of your Secretary of State. Regardless of the type of internet business you run, be sure you secure the proper state business licenses. Most states include online forms for forming an LLC.
Sole Proprietorship Vs LLC: Online Business Finance and taxation
The net tax effect will be the same whether you are a single-member LLC or a solo proprietor: Your federal income will be recorded on Schedule C of IRS Form 1040. According to Ecwid, you will be taxed just once, as opposed to incorporated firm owners, who are taxed twice: once at the corporate level and again on their tax return. Regarding business accounts, most banks handle sole proprietorships and limited liability businesses the same but verify with our financial institution first.
If your online retail business must collect sales tax from in-state clients, your business structure should not affect how you pay this tax to the state. The state’s starting and annual registration costs are the only additional cost of creating an LLC for an online business.
Sole Proprietorship Vs LLC: Online Business Meetings, Records, and Reports
Nonprofit organizations and corporations are obligated to hold board meetings, but LLCs and sole proprietorships are not. Depending on your state’s laws, both types of businesses may be required to report quarterly or monthly sales. The state requires LLCs to make an annual report and a fee to notify the state that they are still in operation. Regardless of the business kind, all other accounting and records for your online retail business will remain the same.
Sole Proprietorship Vs LLC: Online Business Growth Potential
If you intend to expand, hire personnel, increase payroll, or add new business owners, you should now form a limited liability company. While your initial operating agreement will set up your LLC as a single-member LLC run by you, you will be able to change it in the future to accommodate expansion. On the other hand, a sole proprietorship needs more room to expand. However, you can reconstruct your sole proprietorship corporation as a new LLC if you so desire.
Sole Proprietorship vs. LLC in California
California sole proprietorship vs. LLC is a typical question among potential business owners in California when deciding on a business form. Both of these business forms have advantages and disadvantages.
Sole Proprietorship vs. LLC in California: What Are The Differences?
In California, you can operate as a sole proprietor or an LLC, but not both. When deciding between a sole proprietorship and an LLC, you should consider two crucial differences: liability and taxes. A sole proprietorship does not have any legal separation from its owner. The owner will receive all earnings and will be held accountable for all losses and debts.
On the other hand, an LLC provides its members with limited liability, shielding them from personal accountability for the company’s financial commitments. Because the IRS considers a single-member LLC to be a disregarded entity, a sole proprietorship and an LLC are often taxed equally. A single-member LLC normally files its members’ income and costs on the IRS Form 1040, just like a sole proprietorship.
Individuals who desire to be their own boss may profit from forming a sole proprietorship or forming a single-member LLC. This allows you to oversee the company’s management, finance, marketing, and policies. If you are a lone proprietor or owner of a single-member LLC, there is no need to seek consent from other owners or confer with anybody else.
Those new to business ownership may prefer to work with others on critical business decisions. Having other members can help you learn from different experiences, distribute marketing and management responsibilities, and possibly find more money.
To summarize
The initials “LLC” behind your company name look professional, providing you credibility with more customers. They feel more secure knowing you are registered with the authorities and are less likely to flee with their money. Another advantage of forming an LLC is that it protects your business name, which cannot be taken by anyone else once registered with the state. In addition, a sole proprietor has no documents to fill out or procedures to follow if and when you close the firm. An LLC manager, on the other hand, must notify the state of the closure and distribute all assets following the operating agreement.
Frequently Asked Questions
What is better, a sole proprietorship or LLC?
An LLC offers significant benefits in terms of legal protection and liability. While filing expenses are associated with forming an LLC, they might be well worth it compared to the thousands of dollars you could be liable for as a sole owner. A sole proprietorship, on the other hand, is free to establish.
Do LLC pay more taxes than sole proprietorship?
LLCs pay the same amount of taxes as sole proprietorships. Pass-through taxes is available to both an LLC and a sole proprietorship.
Why choose an LLC?
An LLC allows you to get the benefits of both the corporation and the partnership business forms. In most cases, LLCs protect you from personal liability. Your personal assets, such as your car, house, and savings accounts, are not at danger if your LLC goes bankrupt or is sued.
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