Starting a new business comes with a long list of decisions, and one of the most important is choosing the right legal structure. For many entrepreneurs, that choice comes down to two common options: operating their business as a sole proprietorship or registering their business as a limited liability company (LLC). Both have their benefits and both can work well depending on your goals, the nature of your business, and how you plan to grow. In this guide, we’ll break down the key differences in the LLC vs sole proprietorship decision, answer the most frequently asked questions, and help you determine which structure might make the most sense for your business – today and in the future.
What is a Sole Proprietorship?
A sole proprietorship is the simplest and most common business structure in the U.S. It’s an unincorporated business owned and operated by one individual, and it doesn’t require any formal registration with the state beyond standard licenses or permits. If you’ve started freelancing, consulting, or selling goods without forming a legal entity, you’re likely operating as a sole proprietor—whether you realize it or not.
Key Features of a Sole Proprietorship
- Single owner, full control. The business and the owner are legally the same. You make all the decisions, and all income and expenses flow directly to your personal tax return.
- No legal separation. There’s no legal distinction between you and your business, which affects everything from liability to taxes.
- Minimal paperwork. Aside from local business licenses or a DBA (“doing business as”) registration, there’s little administrative overhead to get started.
Pros of Operating as a Sole Proprietor
- Easy setup. You can get up and running without filing formation documents or paying state fees.
- Straightforward taxes. Business income is reported on your personal tax return using a Schedule C. No need to file a separate business return.
- Full control. As the sole owner, you call the shots. No partners, no board meetings, no formalities.
Cons of a Sole Proprietorship
- No liability protection. You’re personally responsible for all debts and legal obligations. That means your personal assets (like your home or savings) could be at risk.
- Limited funding options. Banks and investors typically prefer to work with more formally established entities like LLCs or corporations.
- Harder to scale. While perfect for solo ventures, sole proprietorships can be limiting as your business grows, especially if you plan to hire employees or bring on partners.
What is an LLC (Limited Liability Company)?
A Limited Liability Company, or LLC, is a formal business structure that blends the flexibility of a sole proprietorship with the liability protection of a corporation. It’s one of the most popular choices for small business owners because it offers legal separation between the business and its owner(s) while keeping the operational and tax structure relatively simple. An LLC offers distinct advantages when comparing LLC vs sole proprietorship, especially in terms of protection and flexibility.
Key Features of an LLC
- Separate legal entity. An LLC is legally distinct from its owners (called members), which means the business can own property, enter contracts, and be held liable, while keeping the member’s personal assets separate.
- Flexible management. LLCs can be managed by the members or by appointed managers. There’s no need for a board of directors or corporate officers.
- Pass-through taxation. By default, LLCs are taxed like sole proprietorships or partnerships, with income passing through to members’ personal tax returns.
Pros of Forming an LLC
- Limited liability protection. Your personal assets are generally shielded from business debts and lawsuits – an essential layer of protection.
- Professional credibility. Having “LLC” in your business name can build trust with customers, vendors, and potential partners.
- Flexible tax options. LLCs can elect to be taxed as a sole proprietorship, partnership, S corporation, or even C corporation, depending on what works best for your situation. You can learn more about the S corp election process on the IRS website.
Cons of Forming an LLC
- Formation costs. Setting up an LLC involves state filing fees, which vary by state, and sometimes ongoing annual fees or reports.
- More paperwork. Compared to a sole proprietorship, an LLC has more administrative responsibilities—like keeping business finances separate and maintaining compliance.
- Self-employment taxes. Unless you elect corporate tax treatment, LLC members may be subject to self-employment taxes on their share of profits.
LLC vs Sole Proprietorships: Key Differences Explained
While both LLCs and sole proprietorships are commonly used by small business owners, they differ significantly in how they handle liability, taxes, and operational requirements. Choosing the right structure depends on your priorities – whether it’s minimizing risk, simplifying your taxes, or preparing for growth. The most important distinction in the LLC vs sole proprietorship comparison is liability protection.
Liability Protection
- Sole Proprietorship: Offers no personal liability protection. If your business is sued or owes money, your personal assets could be at risk.
- LLC: Creates a legal buffer between you and your business. In most cases, your personal assets are protected from business liabilities and lawsuits.
Tax Treatment
- Sole Proprietorship: Income and expenses are reported on your personal tax return using Schedule C. You pay income tax and self-employment tax on all profits.
- LLC: Default tax treatment is similar to a sole proprietorship (for single-member LLCs), but you can choose to be taxed as an S corp or C corp if that’s more beneficial. This flexibility can help reduce your self-employment tax burden in some cases.
Formation and Maintenance
- Sole Proprietorship: No state registration is required to form. Setup is simple and inexpensive.
- LLC: Requires filing Articles of Organization with your state, and often an annual report and fee. There’s more paperwork, but also more legal structure.
Perception and Credibility
- Sole Proprietorship: May be seen as less formal or less stable, especially by lenders and partners.
- LLC: Adds legitimacy to your business name and can instill confidence in clients, banks, and vendors.
When Should You Choose a Sole Proprietorship?
A sole proprietorship can be a smart choice for entrepreneurs who want a simple, low-cost way to start a business – especially if the risk is low and the business model is straightforward. It’s not the right fit for everyone, but for certain types of businesses, it’s an efficient way to get off the ground quickly.
Best Scenarios for Sole Proprietors
- You’re testing a business idea. If you’re just starting out and want to validate your concept before investing in a formal structure, a sole proprietorship lets you move fast with minimal costs.
- You’re the only owner. If you don’t plan to bring on partners or investors anytime soon, the simplicity of this model can be a benefit.
- You offer low-liability services. Freelancers, consultants, and digital creators often operate as sole proprietors when their exposure to legal or financial risk is minimal. It’s definitely worth consulting with an attorney to determine how much risk you may be subjecting yourself to based on your business.
- You want to keep things lean. With no state filings or annual compliance requirements, a sole proprietorship is ideal for business owners who want to focus on the work, not the paperwork.
Examples of Businesses that Benefit from this Structure
- Freelance graphic designers, writers, or developers
- Independent consultants or coaches
- Home-based service providers (e.g., virtual assistants)
- Resellers and online shop owners running part-time operations
When is an LLC the Better Choice?
If you’re serious about building a long-term, scalable business, or you simply want more protection and flexibility, forming an LLC can be a smart move. It adds structure and credibility to your operation while shielding your personal assets from potential business liabilities.
Ideal Use Cases for LLCs
- You want liability protection. If your business involves any financial risks such as client contracts, selling physical products, or interacting daily with customers, an LLC helps protect your personal finances.
- You’re planning to grow. If you expect to bring on partners, hire employees, or seek outside funding, an LLC offers the structure investors and collaborators prefer.
- You need to separate business from personal. An LLC makes it easier to open a business bank account, build credit under the business name, and keep clean records for taxes and legal compliance.
- You’re looking for tax flexibility. With the ability to elect S corp or C corp taxation, an LLC gives you options to optimize your tax position as your business grows.
Industry-Specific Considerations
- Service businesses. Professionals in consulting, IT, marketing, and legal services often choose LLCs for both protection and professionalism.
- Retail and eCommerce. If you sell physical goods, whether online or in-store, an LLC helps manage risk and vendor relationships.
- Real estate investors. Property owners and landlords frequently form LLCs to shield personal assets and manage each property as a separate entity.
Costs of Starting and Maintaining Each Structure
Cost is often one of the biggest factors when deciding between a sole proprietorship and an LLC. The truth is, the differences can be significant, not just in startup expenses, but in the ongoing costs of staying compliant.
State Filing Fees and Requirements
- Sole Proprietorship: In most cases, there are no formal filing fees to start. You might need to register a business name (DBA) and obtain a local license, but it’s usually minimal (think $20 to $100 depending on your city or county).
- LLC: You’ll need to file Articles of Organization with the state, and fees vary widely—from around $50 in some states to over $500 in others. Some states also charge an initial franchise tax or publication fee.
Ongoing Compliance and Paperwork
- Sole Proprietorship: Very little. You’ll renew any local business licenses annually and handle personal tax filings, but there’s no required reporting to the state.
- LLC: Many states require an annual report or statement of information, along with a recurring filing fee. You’ll also need to maintain a registered agent (we can help you with that), separate bank accounts, and formal documentation like an operating agreement—even if you’re a single-member LLC.
While the LLC requires more upfront and ongoing investment, the added structure and legal protection often justify the expense—especially if you’re building a business for the long haul.
How to Transition from a Sole Proprietorship to an LLC
Step-by-Step Process
- Choose your LLC name. Make sure it’s unique and complies with your state’s naming rules. It should reflect your brand and include “LLC” or “Limited Liability Company.”
- File Articles of Organization. Submit formation documents with your state’s business filing office (usually the Secretary of State) and pay the required fee. If this sounds a little complicated, you’re right. It can be. We offer reasonably priced LLC formation services with easy online ordering.
- Appoint a registered agent. Your LLC must have a registered agent with a physical address in the state—someone who can receive legal documents on your behalf. If we form your LLC for you, you can elect us to be your registered agent. In fact, some of our packages include our registered agent services!
- Create an operating agreement. Even if it’s not required in your state, this internal document outlines how your LLC will be managed and helps reinforce your limited liability status. Our premium package includes a template operating agreement to get you started.
- Get a new EIN from the IRS. Even if you already had one for your sole proprietorship, your new LLC needs its own Employer Identification Number.
- Update your business licenses and permits. Notify your city or county of the change in structure, and apply for any updated licenses if needed.
- Open a new business bank account. Keep business finances separate from personal to maintain legal protection and simplify accounting. Most banks will require you to show your Articles of Organization in order to open a business bank account.
- Notify clients, vendors, and the IRS. Let everyone know about your new business structure to keep contracts, billing, and taxes aligned.
Legal and Tax Considerations
- Asset transfers. Depending on your situation, you may need to formally transfer any business assets, contracts, or leases to the LLC.
- Tax status. The IRS treats your single-member LLC as a disregarded entity by default, but you can elect S corp status if it makes sense financially. Make sure to speak to your accountant about this to determine if electing S corp status is right for your business.
Transitioning from a sole proprietorship to an LLC doesn’t have to be complicated. For many businesses, the long-term benefits often outweigh the short-term effort.
LLC vs Sole Proprietorship FAQs
Still weighing your options? Here are some of the most common questions business owners ask when deciding between an LLC and a sole proprietorship.
Can You Change from a Sole Proprietorship to an LLC Later?
Do LLCs Pay More Taxes than Sole Proprietors?
Which is Better for my Online Business?
LLC vs Sole Proprietorship: Final Thoughts on Choosing the Right Structure for Your Business
Choosing between a sole proprietorship and an LLC isn’t just about paperwork. It’s about aligning your business structure with your goals, your comfort with risk, and your long-term vision.
If you’re just getting started, operating solo, and looking for the simplest way to launch, a sole proprietorship can be a smart entry point. But if you’re planning to grow, want to shield your personal assets, or are aiming to present your business more professionally, forming an LLC gives you the structure and protection you need. If you have more questions about LLCs, visit our LLC FAQs page for a deep dive into more common questions we receive.
Whatever path you choose, make sure it fits where your business is today and where you want to take it in the future. When you’re ready to move forward, we’re here to help you form your LLC quickly and correctly in any state.
