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by Mike Vestil 

Single Member LLC vs. Sole Proprietorship

Are you thinking about forming a business? Two popular options for small business owners are single-member LLCs and sole proprietorships. Both offer the owner a certain degree of legal protection from personal liability, but there are some distinct differences between them.

In this article, I'll explain the differences in detail and provide insight into determining which suits you best.

Let’s dive deep into this topic.

Is A Single Member LLC A Sole Proprietorship?

No, these are two separate entities and should be considered as such.

What Is An LLC?

An LLC, or limited liability company, is a type of business structure that offers personal liability protection to its owners. This means that the owners of an LLC are not personally liable for any debts or losses incurred by the business. LLCs are popular among small business owners because they offer several benefits, including tax flexibility and limited personal liability.

Answering the question of what is an LLC also means making a distinction between LLC and corporation. Corporations are separate entities from their owners.

This means they must file an individual tax return, have shares of stock available for purchase, and can be sued individually in court. LLCs do not have these distinctions and are considered "pass-through" entities, meaning their profits and losses pass through to their owners' tax returns. This allows business owners to avoid double taxation while enjoying the benefits of limited liability protection.

In addition to offering personal liability protection, LLCs also provide flexibility regarding management structure and ownership rights. Unlike corporations which must appoint directors and register shareholders, LLCs don't need to follow these rules; instead, members can agree on how they should operate the business. As for ownership rights, members of an LLC can have different classes and percentages of interest, allowing them to create custom arrangements that suit their individual needs.

What Is A Sole Proprietorship?

A sole proprietorship is a business owned and operated by one person. There are no shares or partners in a sole proprietorship, and the owner is responsible for all debts and liabilities of the business. Income from a sole proprietorship is taxed as personal income.

This entity type is one of the most accessible and affordable to set up, as no legal formalities or costs are involved. Sole proprietorships also benefit from the owner's direct control over operational decisions. However, sole proprietorships have limited access to capital and may be subject to unlimited personal liability for business debts and obligations. In addition, taxes on a sole proprietorship can be higher than those of other business entities due to their single-owner status.

Sole proprietorships can be especially attractive for businesses that require a minimum initial investment or operate on a small scale, such as freelancers, independent contractors, and artisans. However, larger companies may opt for a different entity structure with more protection and greater access to faster growth opportunities.

Difference Between Single Member LLC vs Sole Proprietorship

The main difference between a single-member LLC and a sole proprietorship is that an LLC offers limited liability protection to its owners. In a sole proprietorship, the owner is personally responsible for any debts or liabilities the business may incur.

Another difference between a single-member LLC and a sole proprietorship is that the IRS treats them differently for tax purposes. Single-member LLCs are not legally separate from their owners, so the LLC’s business income and expenses are reported on the owner's tax return. A sole proprietorship is taxed separately, so one must report all business income and losses on  a separate tax return.

There are also some critical differences in ownership and management of a single-member LLC vs. a sole proprietorship. A single-member LLC is owned and managed by one person, while a sole proprietorship is usually owned and operated by its owner or an authorized representative. An LLC also has the benefit of being able to add additional members if needed, whereas a sole proprietorship can only have one owner. This can provide the potential for growth in an LLC that isn't available with a sole proprietorship.

In terms of fees, an LLC license needs to be obtained from the state, which comes with associated costs. A sole proprietorship does not require a permit and is generally easier and less expensive to set up. Overall, it comes down to personal preference.

Choosing the business structure that fits your needs best depends on various reasons. 

Just remember that an LLC provides more legal protection while offering the potential for growth through additional members if needed.

The Benefits Of Forming An LLC

Here are the main advantages of forming an LLC:

  • Limited Liability Protection: An LLC protects its owners (known as "members") from personal liability for business debts and obligations. This means that creditors can only go after the business's assets, not those of its members.
  • Pass-Through Taxation: An LLC provides pass-through taxation to its members, which means that all profits and losses are passed directly through to each owner's tax return. This pass-through taxation eliminates the need for double taxation associated with corporations.
  • Flexibility In Management Structure: An LLC is a very flexible business ownership structure due to its ability to incorporate different management structures, such as limited partnerships and corporate networks.
  • Easier Access To Business Credit: LLCs often have an easier time accessing business credit than sole proprietorships and partnerships, as creditors view them as more financially stable entities.
  • Flexibility In Ownership Structure: An LLC allows for different ownership structures, including corporations, trusts, estates, and even foreign entities. This makes it easy to add new owners or transfer existing ownership interests within the business.
  • Simplified Legal Requirements: Unlike other businesses, LLCs have fewer legal requirements and paperwork filing obligations with state agencies. As a result, they can be created relatively quickly and easily.

The Benefits Of Being A Sole Proprietor

On the other hand, here are the main benefits of being a sole proprietor:

  • Low start-up costs. Setting up a business as a sole proprietor requires very little capital and can be done with minimal expense.
  • Direct control and responsibility. As the owner, you are in complete control of your business decisions and operations, allowing you to operate as quickly or slowly as you wish without consulting any partners or shareholders.
  • Tax benefits. Sole proprietors can benefit from several deductions on their taxable income, as well as be able to claim tax credits for certain expenses related to the business.

Overall, being a sole proprietor can be highly rewarding, both professionally and personally, allowing you to have complete control over your business decisions and operations while still enjoying the many benefits that come with it. 

How To Form An LLC

Knowing how to start an LLC also means knowing the steps necessary to form a limited liability company. Here's what you need to do:

  • Choose a business name. Choose a name for your LLC that is distinguishable from others in the state and not already in use. Depending on your state's requirements, you may have additional regulations and restrictions regarding business names, so be sure to check them out.
  • Complete Articles of Organization (or Certificate of Formation). Your LLC needs to file articles of organization with the Secretary of State or its equivalent in the state where you operate. This document formally creates your LLC as a legal entity and gives details such as member names, registered agent information, etc. This document formally creates your LLC as a legal entity and gives details such as member names and registered agents.
  • Obtain necessary business licenses and permits. Depending on your business, you may need to obtain state and local licensing or permit documents to operate legally in your jurisdiction. Make sure you understand all the laws governing corporations in your area before getting started.
  • Create an Operating Agreement. An operating agreement outlines how members will manage the LLC's affairs, such as establishing rules for ownership, management structure, voting rights, etc. While it is not required in most states, it is a good idea to create one anyways.
  • Open a business bank account & get an EIN. After you've formed your LLC, you should open a separate bank account for the business and obtain an employer identification number (EIN) from the IRS. This will help keep your finances separate from the company's funds and make filing taxes easier.
  • Notify relevant state agencies of formation. Depending on the nature of your business, you may need to notify other government agencies of your LLC's appearance, such as the Department of Revenue or Department of Labor and Industries, to register for taxes or comply with different regulations specific to certain industries.
  • Stay compliant. Once you've formed your LLC, you must stay up-to-date with all state and federal regulations related to your business. This includes filing taxes, updating information on your articles of the organization when necessary, and more.

On a similar note, closing an LLC involves filing the proper paperwork with the state, dissolving any contracts and agreements related to the business, and notifying relevant parties, such as creditors or suppliers, that you are winding down operations. Consult with a lawyer or accountant before closing an LLC to understand your responsibilities and obligations.

How To Be A Sole Proprietor

Becoming a sole proprietor is relatively easy and doesn't require much paperwork.

In addition, there aren't as many steps if you decide to become a sole proprietor compared to forming an LLC. 

The first thing you will need to do is choose the name of your business. This should accurately reflect what services or products you provide and is easily recognizable by potential customers. It's also essential to make sure that the name isn't already taken—search both online and with your state government to make sure it's available before settling on it.

Next, you'll need to obtain any licenses or permits necessary for operating your business legally in your state and locality. This includes anything from general business permits to professional claims, depending on what type of services or products you provide.

Once you've done those two things, it's time to register with the state government. This will depend on your particular state, so look up the requirements for where your business is based. However, you'll need to complete paperwork that includes information about your business and proof of its existence (a lease document or other evidence).

Finally, you may consider opening a bank account specifically for your business. That way, all income and expenses associated with it can be tracked separately—which will prove invaluable come tax time. Doing this also requires less paperwork than forming an LLC, but it's essential to ensure you comply with all the local regulations.

Single Member LLC vs Sole Proprietorship Taxes

There are critical differences between single-member LLCs and sole proprietorships regarding taxes. Single-member LLCs may be able to take advantage of certain tax deductions and credits that sole proprietorships cannot. For example, the self-employment tax deduction is available to LLCs but not sole proprietorships. Additionally, LLCs may be able to claim a more significant percentage of their business expenses as deductions on their taxes than sole proprietorships.

LLCs also benefit from what is known as pass-through taxation. Any profits or losses generated by the business are passed through to the owner's tax return and taxed accordingly. In comparison, a sole proprietorship must pay self-employment taxes on its income. As a result, LLCs may pay less in taxes overall than a sole proprietorship would.

Which Is Better For You - An LLC Or A Sole Proprietorship?

It depends.

Based on the above points, an LLC may be a better fit if you need to limit personal liability, prefer the flexibility of pass-through taxation, or plan to have multiple owners. A sole proprietorship might be better if you want to start your business quicker and don’t need additional capital from investors.

It's essential to ensure that whatever business structure you choose suits your needs now and in the future. Ultimately, weighing each structure's potential benefits and risks is critical when deciding which type of business entity is right for you. It can also be helpful to consult with an attorney or financial advisor who can help you make this decision.

Difference Between A Single-Member LLC And A Sole Proprietorship - FAQ

Is A Single-Member LLC Considered A Sole Proprietorship?

No, a single-member LLC is not considered a sole proprietorship. A single-member limited liability company (LLC) is legally treated as its business entity, separate and distinct from its owner. This means that the owner of a single-member LLC has protection from personal liability for any debts or other obligations incurred by the LLC.

In contrast, a sole proprietorship is an unincorporated business owned by one individual and does not provide any legal separation between the company and the individual. The sole proprietor is personally liable for all liabilities of the company and debts incurred in connection with it. As such, any lawsuits or judgments against the company will directly affect the owner's assets.

How Do Members Pay Themselves From An LLC?

Paying yourself from an LLC is much like a regular paycheck from an employer. You must set up payroll as an LLC member and employee with the IRS. Depending on your state's regulations and rules, you may be able to use a payroll service or do it yourself.

Once you have set up payroll, you can pay yourself as any other employee would be paid: through direct deposits or checks. Make sure that all members of an LLC are paying themselves correctly by applicable laws and that they report their income to the Internal Revenue Service (IRS). Additionally, keep records of all payments made to each member, so there is evidence of these payments if ever needed for tax purposes.

Single Member LLC vs Sole Proprietorship Florida

Whether your LLC is single or multi-member determines the main difference between a Florida LLC and a Florida sole proprietorship. A Florida single-member LLC is owned and operated by one person, while a multi-member LLC typically has two or more owners.

Conclusion

With the proper knowledge and guidance, you can ensure a smooth transition for your business as it grows. By having the correct information beforehand, you'll be better prepared to make the most informed decisions when starting and running a business.

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About the author 

Mike Vestil

Mike Vestil is the author of the Lazy Man's Guide To Living The Good Life. He also has a YouTube channel with over 700,000 subscribers where he talks about personal development and personal finance.

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