Sole Proprietorship vs. LLC in 2024: The Ultimate Guide

This article compares having a sole proprietorship vs. an LLC, their respective formation processes, and their advantages and disadvantages. It will also discuss how you can select the business entity that suits your needs.

You’ve probably heard about various business entities as an entrepreneur or investor. From LLCs to C Corporations to partnerships, various business structures exist to cater to different businesses and their requirements.

The abundance of options is excellent – untill you have to weigh all their pros and cons and pick the best one for yourself. Even more complicated is to select a combination of these entities to befit your business requirements that may transcend the regulations of one sort of business structure.

Creating a holistic strategy for you that enables you to enjoy the ultimate life of personal and financial freedom is an art that Nomad Capitalist has long mastered.

Through our multi-layered approach, we help you set up companies in tax-free or tax-friendly jurisdictions that go well with your corporate setup and enable you the freedom and resources to create generational wealth and legally reduce your taxes.

Sounds like a service you’ve been looking for? Set up a call with us today, and let us help you go where you’re treated best.

What is A Sole Proprietorship?

A sole proprietorship is an unincorporated business owned and operated by a single individual – hence the name sole proprietorship. It is the default choice for anyone running a business without forming a separate legal entity, like an LLC or S Corporation.

A sole proprietorship doesn’t offer limited liability, meaning no separation exists between your personal and business assets/expenses. As a sole proprietor, you are therefore personally liable for all your business debts and obligations.

As its name suggests, the sole proprietorship can only have one owner – the sole proprietor. If you take on a partner(s), the nature of your business will change to a general partnership.

Typically, contractual workers like freelancers or consultants choose to become sole proprietors. It simplifies their taxes and enables them to operate a business without forming separate (and often costlier) legal entities like LLCs. A sole proprietorship’s ease of formation and straightforward structure makes it a suitable option for new entrepreneurs.

Does that mean a sole proprietorship is a bad option for veteran entrepreneurs? Not all. A sole proprietorship is a good option for anyone (beginner or not) whose business income, operation style, and business type requires this business structure and its perks.

What is A Limited Liability Company (LLC)?

A limited liability company or an LLC is a legal business entity. It is hybrid in nature, meaning it offers the ease of a sole proprietorship and limited liability and tax flexibility of large corporations. An LLC can have one or multiple owners (members).

Once formed, the legal identity of an LLC is separate from its owner. This characteristic of an LLC prevents litigators and creditors from claiming your personal assets if your business is sued or unable to pay debts.

Moreover, an LLC’s bankruptcy is separate from its owner’s. If you have employees, your LLC can shield you from enduring liability for their actions.

What is a Single-Member LLC?

A single-member LLC is similar to a regular LLC. It’s called a single-member LLC because it has one owner or member. A single-member LLC is one of the most preferred business structures in the US.

What is an Anonymous LLC?

An anonymous LLC is also similar to a regular LLC with one difference – it is formed in a state that allows LLC owners to keep the information about owners, members, shareholders, etc., private. In essence, the ownership information of Anonymous LLC is not disclosed in public records, enabling excellent privacy protection.

Typically, single-member LLCs are taxed like sole proprietorships (since both structures have sole owners). However, an LLC can choose to be taxed as an S Corp or a C Corp.

Essentially, an LLC can choose the most cost-effective tax structure for their business, making it a highly flexible option for entrepreneurs.

Advantages of an LLC

Credible Structure

An LLC is one of the most common forms of business in the US. Entrepreneurs love its perks and the flexibility it offers. As such, an LLC is far more credible than a sole proprietorship. It’s often harder to obtain business financing through a sole proprietorship. However, an LLC doesn’t face this issue due to its higher market credibility.

A separate business entity, like an LLC, makes it far easier to obtain equity and debt financing. An established business credit score also helps, of course.

Limited Liability

The most significant advantage of an LLC is in its name – limited liability. LLCs act as a shield between creditors and the LLC owners to protect their personal assets from any lawsuits, business debts, or other obligations. As long as you set up and maintain your LLC properly, keeping your personal and corporate assets separate, and taking all the legal precautions, creditors cannot go after your personal assets in case of a lawsuit.

Flexible Nature

An LLC is very flexible in nature. If you have a single-member LLC, you can elect to be taxed as a sole proprietorship, an S Corp, or a C Corp. Your tax consequences will depend on the structure you chose to be taxed as.

Affordable and Easy to Set Up

An LLC is easy and cheap to set up compared to other structures. Most US states only charge a few hundred dollars to register an LLC. Moreover, the paperwork for most single-member LLCs is only a single page, and with less red tape, you’ll likely enjoy fewer legal fees as well.

Fewer Ownership Restrictions

Unlike S Corps, LLCs can be owned by non-US citizens and residents. They can also be owned by business entities and even certain types of trusts. Foreign ownership is a very beneficial characteristic of LLCs. LLCs can also hold subsidiaries without restriction.

Disadvantages of an LLC

Questions for Local Tax Treatment Abroad

If you use an LLC while living and doing business abroad and don’t fit your US company structure into an overall offshore tax strategy, you may create more problems than ease.

Some countries don’t recognize LLCs, creating ambiguity about the treatment of your LLC under local tax laws.

Others don’t cover limited liability companies under tax treaties established with the US, impacting how dividends and losses are treated for tax purposes. If not planned properly, you can risk double taxation or lose your ability to claim deductions.

Self-Employment Tax

Since you don’t have to take a salary with an LLC as you do with an S Corp, you’ll be required to pay self-employment tax on your entire business income. This also means that you must make quarterly estimated payments to the IRS.

Potential Loss of Protection

An LLC doesn’t enable absolute liability protection in all circumstances. If you don’t show a distinct difference between yourself and the LLC, you may lose the limited liability protection because you pierced the corporate veil by blurring the lines between the two entities.

Advantages of Sole Proprietorship

No State Paperwork Required

As a sole proprietor, you won’t have to deal with state paperwork unless your business needs specific licensing, such as an occupational license. Moreover, you’re not required to submit annual state filings unless it’s mandatory, depending on your industry.

Pass-Through Taxation

A sole proprietorship follows pass-through taxation, meaning all profits and losses are passed through to the owner’s personal tax return. Sole proprietors must fill out the Schedule C tax form filed with the owner’s personal tax return. 

Tax Benefits

A sole proprietor may enjoy the tax benefits of being self-employed. They may deduce certain business expenses (business use of your home or car, etc.), use self-employed retirement plans like Simplified Employee Pension Individual Retirement Accounts (SEP IRAs), or write off regular business expenses such as marketing or business travel costs.

Disadvantages of A Sole Proprietorship

No Limited Liability

A sole proprietor doesn’t get personal liability protection against business debts or lawsuits. You may risk losing your personal assets if you lose a lawsuit against your business.

Harder to Acquire Equity Financing

A sole proprietorship is an unincorporated business run by a single person. Most investors don’t look favorably upon such businesses making it extremely hard for sole proprietors to secure equity financing.

Your business can suffer drastically due to inadequate financing.

Harder to Establish Business Credit

Due to the nature of your business structure, many financial institutions may categorize your loan request as a personal one rather than a business loan. That makes it difficult to establish business credit to obtain debt financing.

Absence of Trade Name

You’ll have lower market credibility if you don’t operate under a trade name. You can resolve this by creating a “Doing Business As” Name (DBA) with your state’s revenue department or the State Secretary. However, doing so will require the establishment and ongoing fees to continue using the DBA name.

Sole proprietorship vs. LLC – Comparison

Setting up an LLC vs. Sole Proprietorship

As a sole proprietorship is an unincorporated business, you don’t need to complete state paperwork to set it up. However, depending on your work, you may have to obtain licenses, permits, or other permissions from your local government. You may also assume a trade name (DBA) through your state’s revenue department or the State Secretary.

On the other hand, forming an LLC is a far more involved process. It usually consists of three significant steps:

• Choose a Business Name: You must select a unique business name that describes your services and makes you stand out.
• Choose a Registered Agent: A registered agent receives formal business mail and legal documents on your behalf.
• Fill in Articles of Organization: Articles of Organization or Association contain information regarding your business name, registered agent, and other essential business details.

Sole proprietorship vs. LLC Taxation

No double taxation (at the individual and corporate level) exists for Sole proprietorships or LLCs. Business profits are passed through to the owners’ personal tax returns in both cases. However, LLCs have far more autonomy in how they elect to be taxed.

Sole proprietors typically report their business expenses and income on Schedule C. This form is filed with the owner’s personal tax return.

When Should You Form an LLC instead of a Sole Proprietorship?

New entrepreneurs may choose a sole proprietorship initially but may choose to switch to an LLC structure later for many reasons. Generally, you should form an LLC in the following situations:

• You want to increase the number of company owners and expand the business.
• You want personal asset protection from future creditors and litigations.
• You want to take advantage of tax benefits that come with forming an LLC

People usually consider switching to an LLC to grow their business in member numbers or scale. Some also do so when they have enough income to afford an LLC establishment fee and yearly maintenance.

LLC or Sole Proprietorship – Which is Best?

It depends. The best business structure for you is the one that best befits your business income, scale, expenses, and tax consequences.

Forming an S Corp as a startup seeking funding may not work since foreign investors are not allowed to invest in an S Corp. Similarly, a sole proprietorship won’t work if you want to take on business partners.

Unless you have a grand-scale publicly traded company, an LLC will work for a wide variety of businesses owing to its flexibility. In the case of a massive publicly traded company, a C Corp may suit your business needs better.

You should always adopt a holistic strategy before forming a company – exactly what we do for our clients here at Nomad Capitalist. If done right, you can save thousands of dollars and numerous headaches. Feel free to reach out if you’d like help figuring out which structure works best for you.

Sole Proprietorship vs. LLC in 2024: The Ultimate Guide FAQ