Limited Liability Companies (LLCs) are business structures in the US that protect the owners from liability. As The Balance SMB notes, this business structure serves to protect the owner's personal assets while still allowing income to filter through to their personal accounts. Owners of LLCs are not personally liable if the LLC is under litigation. As a result, none of the owner's personal assets can be leveraged in a settlement, protecting them from any legal ramifications of their business practices. LLCs offer several benefits to owners in addition to these protections. Some of these benefits include:
- Tax Savings: LLCs are pass-through entities as far as federal tax is concerned. The savings that a businessperson makes from taxes can be used to pay for the formation of the business.
- Protection from liability: As mentioned above, the business assets are separate from the owner's assets.
- Privacy: In some jurisdictions, a business can be registered anonymously, allowing the owners to benefit from some privacy. Generally, the owners' names and addresses are publicly accessible.
- Professionalism: having a business registered within a state makes for a more professional front end for an individual. Firms and people prefer interacting with registered entities.
- Flexible Taxation: LLCs can be taxed as either corporation or as limited liability companies. Each may have its benefits and drawbacks.
- Complexity: The LLC is a complex structure and needs to be filed with the state along with requisite paperwork. This stipulation may make it a bit harder to register as an LLC on one's own.
Sole Proprietorship In Comparison
According to Entrepreneur, a sole proprietorship is the simplest method of incorporating a business. If you're any type of professional and operate out of your home without any registration documents, your business is classed as a sole proprietorship. The owner tends to pay all the taxes from the proceeds of the company. The sole proprietorship has a few notable traits as well:
- Higher taxes: The sole proprietorship's income includes everything the owner makes through the business. As a result, there are no deductions made for expenditures or business expenses, meaning a much higher tax burden at the end of the season.
- Unlimited Liability: If the sole proprietorship is involved in a situation where the business may be taken to court, the settlement may leverage the owner's assets alongside the company to pay for the settlement. There is no separation of assets here, and all of the owner's assets are considered belonging to their business and vice versa.
- Difficult to Raise Capital: Sole proprietorships need to rely on donations or earnings to raise capital. If they operate on a shoestring budget or barely clear their expenses, they might not be able to grow since they can't tap into investors of members to help them raise capital.
- Unprofessional: Since there isn't any effort needed to establish a sole proprietorship, these businesses are usually viewed as unprofessional. They don't command the same respect as a business with the LLC or Ltd. legend after its name.
Crucial Differences Between the LLC and the Sole Proprietorship
Sole proprietorships are usually single operators that set up a part-time business as a side hustle. They don't concern themselves with taxation complications and sometimes don't even pay taxes on their earnings. However, they can run afoul; of tax law because of this practice. It costs nothing to set up a sole proprietorship, but LLCs have a filing cost associated with registering with the state registrar. The LLC offers a lot more flexibility in taxation and can even change how it pays tax from an LLC into a corporation. LLCs also provide liability protections that sole proprietorships do not.
Funding an LLC Opposed to a Sole Proprietorship
Sole proprietors tend to be in a bind when it comes to leveraging funding. LLCs have access to several means of getting financing, thanks to their registered status. Banks look forward to proposals from LLCs because they are a reliable source of continuing income from loans. Investors are, similarly, interested in LLCs since they can get a good return on their investment if the company's ideas are good. Unfortunately, sole proprietorships don't have this same ease of acquiring funds. Because of their unregistered status, investors are unlikely to spend money on them. Banks, similarly, see those businesses as illegitimate and are willing to offer the owner a personal loan, but not a business loan.
Managing and Operating
Sole proprietorships usually have complete freedom of operation since the sole owner undertakes their decisions. There's no management structure, which can be both a blessing and a curse. The sole owner is also the only employee of the business, which can take a toll on their time availability. LLCs may be owned by one or more members who form the board. In larger LLCs the board may appoint a manager to deal with the daily running of the company. How the company runs and its internal processes are usually outlined by a document known as the operating agreement. While not all LLCs have an operating agreement, it's in the company's best interest to establish one.
Taxation of Both Entities
LLC income is only taxed once since the company is considered a "pass-through" entity for tax purposes. However, LLCs may have the option of being taxed as a corporation if they so please. In such a case, their revenue may be taxed twice. Firstly, at the corporation level, and secondly, at the individual level. Sole proprietors are only taxed as individuals, with all their income being recorded as a stable income. LLCs have the option of writing off some of their income as deductibles, allowing for a lower tax burden overall. State taxes are similar in both cases, except some states don't tax LLCs, making them a strictly better option in those locales than a sole proprietorship.
LLC or Sole Proprietorship - Which is Better?
LLCs tend to offer better protections for their members than a sole proprietorship. Since legal matters can't really be predicted, an LLC may be a better choice for a professional trying to legitimize their business operations. However, the cost of filing an LLC may be steep in some locations. Sole proprietorships also allow for added freedom since there's little need for an established board. Unfortunately, if the income from the company goes above a certain level, the "pass-through" taxation the business structure offers may be more of a blessing than a curse. Discussing the choice of LLC or sole proprietorship with a lawyer may give you some insight into which one better suits your business.