LLC vs. sole proprietorship: which is right for a new business?
Last reviewed . General information, not legal or tax advice.
A sole proprietorship is the default when you do business alone without registering: it is free and simple, but your personal assets are exposed to business debts and lawsuits. An LLC is a separate entity registered with your state that usually protects personal assets. By default both are taxed on your personal return, with self-employment tax on profits.
What is the difference between an LLC and a sole proprietorship?
The main difference is liability. A sole proprietorship is not a separate legal entity, so the SBA notes you can be held personally liable for the business's debts and obligations. An LLC is a separate entity; in most instances, the SBA says, your personal assets such as your car, house and savings are not at risk if the LLC faces bankruptcy or a lawsuit.
| Feature | Sole proprietorship | Single-member LLC |
|---|---|---|
| How it starts | Automatically, when you do business alone without registering another structure | You file formation documents (often called articles of organization) with your state |
| Personal liability | Unlimited: business debts and claims can reach personal assets | Owners are generally not personally liable |
| Federal income tax by default | Schedule C on your Form 1040 | Disregarded entity: also reported on your own return unless it elects corporate tax treatment |
| Self-employment tax | Yes, on net earnings | Yes, on net earnings, by default |
| Cost to start | Usually none beyond local licenses and a DBA if needed | A state filing fee, a registered agent and possibly annual fees |
| Ongoing paperwork | Minimal | State reports, a registered agent and separate records |
How are they taxed?
For federal income tax, the two often look the same. A sole proprietor reports business profit or loss on Schedule C with Form 1040 and pays self-employment tax on Schedule SE. The IRS treats an LLC with one member as a "disregarded entity" by default, so its income lands on the owner's return the same way, unless the LLC files Form 8832 to be taxed as a corporation.
An LLC with two or more members is treated as a partnership by default. An LLC can also choose to be taxed as an S corporation (by filing Form 2553) or a C corporation; see LLC vs S corp. The SBA notes these setups are less common and harder to set up, and suggests talking to a business counselor or attorney first. Self-employment tax and estimated payments are explained in self-employment and estimated taxes.
When is a sole proprietorship enough?
The SBA describes a sole proprietorship as a good choice for low-risk businesses and for owners who want to test an idea before forming something more formal. It may be enough when:
- You are testing demand with a few customers or a side project.
- The work carries little risk of injury or property damage, such as writing, design or tutoring online.
- You have few personal assets at stake, and insurance covers the realistic risks.
- You want to avoid state filing and annual fees until the business proves itself.
Using a name other than your own still usually means registering a DBA. See business names, DBAs and trademarks.
When should I form an LLC instead?
The SBA describes an LLC as a good choice for medium- or higher-risk businesses and for owners with significant personal assets they want protected. Signs it may be time to switch:
- You sell a physical product that could injure someone, or customers come to your home or workspace.
- You sign leases, take on debt or hire people.
- Sales are growing and a lawsuit or unpaid bill could now be large.
- A partner joins, which makes an operating agreement important.
Liability protection has limits, the SBA notes, and keeping business money in its own bank account is part of keeping the business separate from you. Insurance fills the remaining gaps; see small business insurance.
Can I switch from a sole proprietorship to an LLC later?
Yes. You form the LLC with your state and move the business into it: contracts, bank accounts, licenses and permits. The SBA notes that you generally need a new EIN when your business's ownership or structure changes, so check with the IRS before you reuse an old number.
The SBA cautions that converting can have restrictions depending on your location, and may have tax consequences, so plan the switch rather than doing it in a rush. The filing steps are in how to start an LLC.
Frequently asked questions
Does an LLC save money on taxes?
Not by default. A single-member LLC is a disregarded entity for federal income tax, so its profit is taxed on your personal return with self-employment tax, just like a sole proprietorship. Tax savings, if any, come from electing S corporation or C corporation treatment, which adds filings and costs, so get professional advice first.
Do I need an LLC to sell online or on Etsy?
You don't need an LLC to sell online. Anyone doing business alone without registering another structure is a sole proprietor by default and can sell under their own name. You still need the sales tax registration, licenses and tax reporting that apply. Consider an LLC when product liability, growing sales or personal assets make protection worth it.
Is a single-member LLC the same as a sole proprietorship for taxes?
For federal income tax, mostly yes by default. The IRS treats a one-member LLC as a disregarded entity, so you report its income on Schedule C, unless it elects to be taxed as a corporation. Legally it is different: the LLC is a separate entity, and state fees and reports may apply.
Do I have to report owners to FinCEN?
Not if your company was created in the United States. FinCEN's current guidance says U.S. companies are exempt from beneficial ownership information reporting and no longer need to file. Only certain foreign companies registered to do business in a U.S. state still report. Check fincen.gov for changes.
Sources
- Choose a business structure, U.S. Small Business Administration. https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
- Sole proprietorships, Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/sole-proprietorships
- Limited liability company (LLC), Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc
- Self-employment tax (Social Security and Medicare taxes), Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes
- Register your business, U.S. Small Business Administration. https://www.sba.gov/business-guide/launch-your-business/register-your-business
- Get federal and state tax ID numbers, U.S. Small Business Administration. https://www.sba.gov/business-guide/launch-your-business/get-federal-state-tax-id-numbers
- Open a business bank account, U.S. Small Business Administration. https://www.sba.gov/business-guide/launch-your-business/open-business-bank-account
- Beneficial ownership information reporting, Financial Crimes Enforcement Network. https://www.fincen.gov/boi
This guide is general information, not legal or tax advice. Rules differ by state and city and change over time, so confirm the details with the official sources above or a licensed professional.