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LLC vs. Sole Proprietorship: Know the Tax Benefits
  • 20 October 2016
  • Eric Michaels

LLC vs. Sole Proprietorship: Know the Tax Benefits

Starting a business requires more than a great idea. Among other things, entrepreneurs have to take into account the company's classification in the tax system and what will happen if the company goes bankrupt. How you set up your business could be the difference between losing your personal property or simply losing your investment in the company. They are called limited liability companies (LLCs) for a reason.

Deciding between an LLC vs. sole proprietorship is nothing to take lightly. Here are key points to consider before making the call.

Start-Up Costs

There are more sole proprietorships in America than any other type of business for obvious reasons—it's the easiest and least expensive way to start a company. As long as you obtain all applicable licenses and permits, anyone can launch a business as a sole proprietor with minimal paperwork and expenses. If there are no licenses to acquire (say, as a blogger or YouTube star), it can cost little to nothing.

Founding an LLC, on the other hand, takes a healthy dose of paperwork and a bit of cash. According to the U.S. Small Business Administration, the process begins with choosing a name and registering your business in your state. Then, you must file "articles of organization," secure licenses and permits, create an operating agreement, and (in Arizona and New York) announce your business publicly. Business owners may spend up to $1,000 on the formation process.


While there are tax implications for most business decisions, deciding between an LLC and a sole proprietorship often does not impact an entrepreneur's filing status. The IRS treats the income from both business types as personal income, meaning it must be reported on your tax return regardless of the classification.

When there are multiple owners of a company, each person reports the income from the company on his or her personal tax returns. If you launch an LLC on your own, there will be absolutely no difference compared to if you filed as a sole proprietor. In other words, self-employment taxes still apply.

Legal Liability

The "limited liability" element of LLC hints at the advantages entrepreneurs have access to when deciding on this type of business formation. As a sole proprietor, business owners are responsible for any debt incurred by the company and any lawsuit brought against the company. Therefore, your personal assets—including your home and car—may be at risk.

If you take the time and spend the money to form an LLC, you only risk the money you invest in the company. Your personal assets remain protected from lawsuits, loan defaults and other ramifications. This advantage is negated if you guarantee an LLC loan with personal funds or assets.

Raising Money in an LLC vs. Sole Proprietorship

When trying to secure financing for a business, sole proprietors must put up their own assets in exchange for a loan. As mentioned above, this puts entrepreneurs at risk while limiting the amount of money they can secure in any round of funding. Meanwhile, your personal credit rating and loan history will have an impact on how any bank or lender views your application.

As an LLC, business owners can leverage company assets as well as personal wealth. The best-case scenario for raising money would be having multiple partners in an LLC to pool resources and obtain a higher loan amount. Though your profits can be subject to a ceiling in this setup, your risk remains whatever stake you have in the LLC.

Though tax liability is similar in an LLC vs. sole proprietorship, there are many other factors to consider before launching a company. Consult an attorney and tax advisor before taking the plunge.

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