Let’s start with an astounding stat: in March 2021, nearly 440K new business applications were filed in the US. If you also intend to start a new business, you’re not alone.
However, it’s important to decide your business structure right at the outset.
That’s because business structure governs your tax liability, operations, and overall management.
When we talk of entity structures, sole proprietorship and LLC (limited liability company) are popular choices among entrepreneurs, owing to their ease of formation.
However, there’s a general confusion about how these two structures differ from each other. In this post, we will delve into this topic in detail.
Let’s get started.
Process and Cost of Formation
Sole proprietorships are easy to form and run. They can be made under the owner’s name or a fictitious name. In the latter case, you will have to file for a Doing Business As or DBA. Moreover, you will be required to pay a filing fee in the state where your business is formed.
For forming an LLC, you will have to file with the Secretary of State for an additional document called “Articles of Organization.” It is a formal document that outlines clauses related to the LLC’s operations, profit-sharing, and taxation.
Apart from the state filing fees, you may have to pay a recurring annual fee in most US states, which ranges from $50 to $500.
Arrangement of Ownership
Sole proprietorships, as the name implies, can be owned by a single individual. LLCs are typically owned by a group of entities called “Members.” Members can be individuals, foreign entities, or even other LLCs, but they cannot be banks or insurance companies.
In the sole proprietorship structure, the proprietor can declare the business income in their personal income statements. Tax is computed on the combined income (personal + business) tax. Along with that, the owner is liable to pay a self-employment tax to the US federal government.
In the LLC structure, all members “pass through” the business profits and losses to their personal income. They can also opt to be taxed as a corporation. To take advantage of limited tax liability associated with an LLC, members should maintain personal and business accounts separately.
Now that you know the main difference between an LLC and a sole proprietorship, you are better positioned to decide which structure suits your business needs the best.
However, there are many other minute differences that can impact your decision in a big way. To understand them, you can check out this infographic by GovDocFiling.