The discussion between an LLC and a sole proprietorship focuses primarily on four major areas: liability, asset protection, tax consequences and costs. To determine which entity is best for your business a short introduction on each area is necessary.
The main benefit of an LLC is that it provides “corporate shield” protection to protect an owner of a business from personal liability for business dealings. It requires business to be started by taking specific actions. No specific action however, is required to start a sole proprietorship. Therefore, for the discussion between a sole proprietorship versus an LLC, a sole proprietorship does not provide liability protection. An LLC has the exact same corporate shield as a “traditional” corporation.
In the event of a lawsuit, the person who formed the LLC is usually sued personally along with the LLC or corporation. This is where it will be important to have followed to correct formalities to start and continue to run the LLC. If this has not occurred, the person bringing the lawsuit will claim the LLC is not valid, and they may be allowed to “pierce the corporate veil.” If this happens the LLC and the person who started it will both be liable, as if it had been a sole proprietorship.
A previous blog article entitled “How Do I Form an LLC” described the steps necessary to correctly form an LLC. Some key steps include filing articles, and not co-mingling funds, for more information refer to our prior blog as indicated above.
An LLC can also protect personal assets with the corporate shield. Not only that, but the same is true in reverse as well, that is, it can protect business assets from personal liabilities. Asset protection is an important for two reasons. Many personal liabilities can derail an otherwise successful business, including unforeseen injuries and medical bills. Moreover, a successful business owner may acquire significant personal assets prior to a business faltering. With a properly formed LLC the assets of the business and the person are kept separate.
The third major factor to consider are the tax consequences of an LLC versus a corporation. Generally, a single member LLC is taxed the same as a sole proprietorship. A sole member LLC will be required to file tax returns the same as a sole proprietorship. In essence, between an LLC and a sole proprietorship there is no difference unless the LLC is planning on filing for a different status with the IRS. However, for purposes of this blog the LLC will be assumed at the default tax status.
The final major area of consideration is the cost of forming and maintaining an LLC versus a sole proprietorship. Generally, LLC’s have a higher startup cost and more ongoing maintenance costs than a sole proprietorship. Sometimes, because of the formalities required to set up an LLC correctly, it may be beneficial to hire an attorney to properly draft and execute the documents. This is especially true if an LLC is less common or being formed by more than one member. As described in our previous blog article there are many formalities to follow when starting an LLC. Whereas a sole proprietorship may simply require filing the Corporation Commission. Each case is different and will be determined by what the business owner is trying to accomplish, what the concerns are, and what the best means of protection will be.
If you have additional questions about what type of entity is best for your particular business schedule a free consultation with one of our experienced attorney to get the advice you need to best protect your business and yourself.