There are many ways to set up a business entity. Some entrepreneurs prefer a corporate structure, while others lean toward a sole proprietorship or a limited liability company, or LLC. While LLCs and sole proprietorships do have some similarities, there are major differences, and you should carefully consider your particular circumstances before you do decide upon a structure for your new venture.
A sole proprietorship is basically the business owner. No separate entity is necessary and there are really no differences between personal and business assets, because, again, there is no separation between the owner/proprietor and the business. These types of arrangements date way back to times when families owned small grocery stores or repair businesses. All money taken in belongs to the proprietor and any money left after deductible expenses is taxable. A sole proprietorship is the simplest and easiest way to operate a business.
You certainly have lower start-up costs if you structure your business as a sole proprietorship. Sometimes it is only $50 to register your business and you’re all set to go.
Since you really don’t have an entity, there are no annual compliance documents to fill out. Again, all income amounts and expenses are recorded on your personal tax return, and you are free to co-mingle business and personal expenses.
The main disadvantage of a sole proprietorship is liability. While a corporation shields the entity owners from personal liability, your sole proprietorship will not. If you own a restaurant and your negligence causes patrons to become ill, everything you own may be vulnerable if you are sued in court. Furthermore, you as a sole proprietor are absolutely personally liable for any debts you incur while operating the business, and your assets are not protected.
A Limited Liability Company is sort of a cross between a corporation and a sole proprietorship. An LLC is a separate business entity. It consists of persons called members, and it does limit personal liability. If your LLC is sued for liability or debt, your personal assets are in many cases protected.
Like a sole-proprietorship, any profits from the operation of your LLC are merely passed through and taxed personally on your form 1040. Furthermore, if there are losses, these will directly offset your personal income for a particular tax year.
Since LLCs are separate entities, however, there can be greater start-up costs and there are definitely annual forms and tax returns that need to be filed. While a small sole proprietor may be able to handle taxes himself, most LLC members hire accounting professionals to complete their yearly tax requirements. That way you don’t need to take online business courses to do your taxes.
Basically, the smaller and less complicated your business is the more chance that a sole proprietorship will work for you. When your volume increases and you have important assets to protect, you should consider an LLC.