Should I select an LLC vs. sole proprietorship? That’s the question that I’ve been asking myself lately as I look at small business planning.
You see, I’ve been an independent contractor / freelancer for a long time. However, I’ve recently started thinking that it makes financial sense to separate my personal and business money. Of course, there are many different ways to do that, but setting myself up as a business seems to be a good next step.
Most likely I’m going to go with a sole proprietorship. I had that kind of business a long time ago and it seemed to suit me just fine. Nevertheless, I don’t just want to jump in willy nilly, so I’m carefully exploring the differences between LLC vs sole proprietorship to make sure I go down the right path.
LLC vs. Sole Proprietorship: Liability
There are many different ways to structure a business. I’ve narrowed it down to LLC vs sole proprietorship. The main difference as I’ve always understood is about my own personal liability. An LLC is a “limited liability corporation” which means that I as an individual have limited liability in comparison to if I were a sole proprietor. In other words, if someone sues my business and I lose, the costs can only affect my business, not my personal finances. In contrast, as a sole proprietor, I’m personally still responsible for the costs of the business. The same is true for creditor issues. It’s worth taking that liability into consideration.
LLCs Cost More to Set Up
Although that limited liability is nice, it comes with a price. It doesn’t really cost much at all to set up a sole proprietorship business. In contrast, there are a lot of fees involved with setting up an LLC. You have to register with the state so there are fees associated with registration and filing documents. Oftentimes, LLCs are also subject to ongoing annual fees. In other words, if you don’t pay each year, then you don’t maintain your LLC registration. You don’t have those costs associated with setting up a sole proprietor business. In general, LLCs are subject to a lot more regulations, which can mean more paperwork, which can mean more time and money.
LLC vs. Sole Proprietorship: Taxes
I currently pay taxes as a self-employed person. If I choose to set up my business as a sole proprietor then I will still pay taxes as a self-employed person. Therefore, for better or worse, my tax situation isn’t going to change. Things seem a little bit more complicated if I decide to set up an LLC. An LLC can be a partnership or a corporation, but it can also be solely-owned. In the later case, it would be taxed like a sole proprietorship.
Therefore, there doesn’t seem to be a huge tax difference for me personally by doing LLC vs sole proprietorship. That said, if I opted to file as a corporation, that could make a difference, which is something worth exploring more. If I do an LLC, I’ll have to file separate business and personal taxes, which I wouldn’t have to do if I set up as a sole proprietor.
Separating Business and Personal Finances
The main reason that I was planning to set myself up as a business is because I want to separate my finances. However, I’m leaning towards doing a sole proprietorship, which actually doesn’t require me to separate my finances. An LLC strictly requires that you keep your business and personal expenses entirely separate. In contrast, you don’t have to do that with a sole proprietorship. You are the business. Therefore, that part wouldn’t actually be different than what I’m doing now as a freelancer. Of course, I still want to separate them, but in the eyes of the government, they wouldn’t need to be.
A sole proprietorship is the right thing for me. My business finances are pretty simple. I don’t run a lot of risk regarding liability. And I don’t want to spend the extra money to become an LLC. But anyone making this decision should certainly look at both options with an eye towards what makes financial sense for them.