Sole Proprietor or LLC? Uncover the Key Differences for 2025

Are you considering launching your own business? With over 580 million entrepreneurs worldwide, you’re certainly not alone in this pursuit.

One of the initial decisions you’ll face is choosing the right type of business structure. Among the simplest options are sole proprietorships and LLCs (limited liability companies).

This article provides a comparison between sole proprietorships and LLCs to help you determine which suits your needs best.

Starting a business as a sole proprietor offers several key benefits. First, its setup process is straightforward and low-cost. Additionally, managing a sole proprietorship is simple, giving the owner full control over decision-making. For entrepreneurs testing a new idea, this structure is ideal since it requires minimal commitment and risk. Typically, owners register the business under their name, but they also have the option to operate under a different business name through a DBA (doing business as) registration.

A limited liability company (LLC) is a business entity designed to provide personal liability protection to its owners. Setting up an LLC involves several steps that vary by state, including submitting articles of organization—similar to a partnership agreement or corporate bylaws—and establishing an operating agreement that defines ownership and management rules. Another important element is appointing a registered agent, who accepts legal documents on behalf of the LLC. You can also choose to form a multi-member LLC if there are multiple owners. Costs and procedures to form an LLC differ depending on the state, but using a reputable LLC formation service can ensure you meet all legal requirements smoothly.

Understanding the differences between a sole proprietorship and an LLC is critical for entrepreneurs who want to minimize personal risk. An LLC provides limited liability, meaning the owner’s personal assets are protected if the business faces legal issues or debts. Tax benefits are another advantage, as LLC owners can deduct business expenses and choose how their income is taxed. For tax purposes, a sole proprietorship is considered a disregarded entity by the state, with owners reporting social security and Medicare taxes directly on their tax returns. In contrast, the state may classify an LLC as a partnership or corporation for tax purposes. These factors often lead entrepreneurs to prefer sole proprietorships for low-risk ventures, but this simplicity comes with disadvantages—specifically, unlimited personal liability. If the business is sued or cannot pay debts, the owner’s personal assets are vulnerable.

Taxation varies based on the chosen business structure. LLCs offer tax advantages, including pass-through taxation, where profits and losses pass directly to the owners’ personal tax returns. This often results in a lower personal tax rate compared to corporate tax. Both LLCs and sole proprietorships generally benefit from lower self-employment taxes than corporations, making them attractive options for small business owners.

Forming an LLC involves filing Articles of Organization with the state and paying associated fees, making it more complex than registering a sole proprietorship, which typically requires no formal filing beyond local permits or licenses. When it comes to tax reporting, LLC owners need to include business income on their personal tax returns, often via Schedule C. Sole proprietors also report profits and losses using Schedule C, keeping the process relatively simple.

An LLC is recognized as a separate legal entity, offering limited liability protection that shields personal assets from business debts or legal actions. This is a significant advantage over a sole proprietorship, where the owner’s personal assets are fully exposed to business liabilities.

Creating an LLC requires more effort upfront, including filing paperwork and paying fees, whereas establishing a sole proprietorship is easy and inexpensive. During operation, both structures are similar, but an LLC continues to exist independently of the owner, unless explicitly dissolved. A sole proprietorship, however, usually ends when the owner leaves or passes away, unless specific arrangements are made for its continuation.

Depending on your business type, obtaining certain licenses or permits is essential—regardless of whether your business is a sole proprietorship or an LLC. Examples include liquor licenses for alcohol sales, food handler permits for restaurants, or special licenses for dealing with hazardous materials. Ensuring compliance with local regulations is a necessary part of running any business.

Maintaining a separate bank account for your business transactions is highly recommended to keep finances clear and organized. This practice helps separate personal assets from business funds and simplifies tax preparation and financial management.Your assets should be protected from business debts.

For LLCs, legal regulations require this separation.

Opening a business bank account is a straightforward process that can typically be completed online or in person at most banks.

Mixing Business Funds And Personal Finances

As a sole proprietor, there’s little distinction between your personal and business finances. However, it’s advisable to keep them separate to ensure clarity. In contrast, an LLC requires this separation because of its legal distinction from the owner.

Does Your Business Name Need To Be Registered?

If you’re operating as an LLC, registering your business name with the state is mandatory. The law also mandates including “limited liability company” or “LLC” in your business name. The registration process is relatively simple and costs between $100 and $500, depending on the state.

For sole proprietors, whether you need to register your business name depends on specific circumstances. If your business name includes certain restricted words or phrases or if you’re using a fictitious name different from your personal name, registration is typically required. The process and fees are usually similar to those for forming an LLC.

Pros And Cons

Sole Proprietorship Advantages

Being a sole proprietor gives you full control over your business. You can start without filing any special paperwork, and establishing your business is quick and easy. You also have the flexibility to change your business structure anytime without legal issues. Additionally, you only pay self-employment taxes on your business income.

Disadvantages of a Sole Proprietorship

However, sole proprietors are personally liable for all debts and obligations. Raising capital can be challenging since you’re the only owner, and there’s no legal separation between personal and business finances.

Forming An LLC: Pros & Cons

Benefits

An LLC provides limited liability protection, safeguarding your personal assets if the business faces lawsuits or debts. This protection can make it easier to attract investors, as they prefer the security of asset protection. Additionally, LLCs can be taxed as an S corporation, avoiding double taxation and potentially reducing tax burdens compared to sole proprietorships or partnerships.

Drawbacks

On the downside, LLCs often require annual reports and fees, varying by state. They usually do not qualify for Medicare or Medicaid, meaning owners must find other health coverage options. Also, altering your business structure later involves dissolving the LLC and forming a new one, which can be costly and time-consuming.

FAQ: Sole Proprietorship vs. LLC

What Is An S Corp?

In the U.S., an S corporation is a business that has elected to be taxed under Subchapter S of the Internal Revenue Code, which helps avoid double taxation of income. To qualify, all shareholders must elect this status.

What Does The Secretary Of State Do?

They keep track of business registrations, maintain public records, oversee elections, and manage notary applications.

Is An LLC Or Sole Proprietorship Better For New Business Owners?

There’s no universal answer; the optimal choice depends on the type of business, your goals, and financial situation. Generally, LLCs offer more flexibility and protections than sole proprietorships.

Do Business Owners Pay Personal Income Tax As An LLC?

No, LLC owners are taxed based on their share of the profits, not through personal income tax directly.

Must I File a Personal Tax Return for an LLC?

No, the LLC files its own tax return, and owners report their share of profits or losses on their personal returns.

Are Personal and Business Assets Separate in an LLC?

Yes, LLCs keep personal and business assets distinct. If sued or bankrupt, your personal assets are protected.

What Are Tax Benefits For An LLC?

LLCs benefit from pass-through taxation, the ability to deduct business expenses, and the option to elect corporate tax treatment for further savings.

Is It Easier To Obtain Business Credit With An LLC?

Generally, yes. Lenders see LLCs as separate legal entities, making them less risky and more likely to qualify for loans.

Wrap Up

Understanding the differences between a sole proprietorship and an LLC can help you choose the best structure for your business. Starting as a sole proprietor is straightforward, but you’re personally responsible for all debts. An LLC offers asset protection but involves additional costs and paperwork. The final decision should align with your business needs and goals.

Further resources on StepThroughThePortal.com include guides on selecting a registered agent service, setup assistance, and choosing a business checking account for LLCs. Using professional services can simplify compliance, saving time and reducing legal risks. Check out my recommended LLC service providers for top options to help your business succeed.