During August the Tax Foundation noted that claiming “the President’s agenda will protect 97 percent of small business owners from income tax increases” can be a misleading figure. The Tax Foundation states that in order to assess the economic effect of higher marginal tax rates, it matters how much investment or income would be affected. The Tax Foundation estimates that only 6% of filers with pass-through income would be affected.
When starting a business venture entrepreneurs could experience a bit of choice paralysis when having to weigh up the pros and cons of a sole proprietorship versus the LLC. What follows is a comparison between both business structures on several key points.
As a relatively simple entity type for new business, the sole proprietorship is a popular choice for aspiring entrepreneurs in various industries. This informal business type does not require any registration with the state government, however depending on where the entrepreneur lives business licenses or zoning permits to legally operate the sole proprietorship may apply. Any business that operates under a trade name needs to apply for a DBA (doing business as) certificate.
The LLC, on the other hand, may need to file for business permits and a DBA, but the most important formation document required here is the Articles of Organization. This document establishes the LLC’s existence and must be filed with the state in which the LLC is operating. Cost of LLC formation varies by state.
Operations and Management
The sole proprietorship generally has a simple operational and management structure, as there is just one person calling the shots. The owner can make any business decisions without the need of third-party input. Most sole proprietors do end up hiring employees, legal and accounting experts as well as other individuals to assist the day-to-day business activities. However the sole proprietor only needs to ensure that the business is operating safely, legally and that there is enough profit to cover business debts.
The LLC has a slightly more complicated management structure which is usually outlined in the operating agreement. California, New York, Missouri, Maine, and Delaware are among the states that require LLCs to have an operating agreement. The operating agreement outlines each member’s ownership stake in the business, profit share and voting rights. Furthermore, the LLC can be collectively managed by all the members or by an appointed manager.
In this arena the LLC outshines the sole proprietorship. Since an LLC is a legally separate entity from the owner(s), the owner(s) can not be held personally liable for the business’s obligations. However, in some cases this legal protection can become null and void. This is especially true if it was found that members have committed fraud, or made fraudulent representations or omissions when applying for business loans. In such cases it is possible that the members can be held personally liable for the resulting harm to the creditor and may risk losing their personal assets.
In the case of a sole proprietorship there exists no legal separation between the business and the owner. Which means the owner is personally responsible for business debts. In the event that the business goes bankrupt, the sole proprietor needs to file for personal bankruptcy. Bankruptcy proceedings normally include business and personal debts. Additionally, should the sole proprietorship be sued.
Taxes: Only LLCs Can Choose Corporate Tax Status
A notable difference between the LLC and sole proprietorship has to do with tax flexibility. LLC owners have the privilege of choosing how they want their business ventures to be taxed, with options of staying with the default pass-through taxation, or electing to be taxed as an S-corporation or C-corporation. The S-corporation is treated as a pass-through entity, and may be useful to avoid double taxation issues.
In addition to income taxes, both the LLC and sole proprietorship may have additional tax responsibilities. Regardless of the business structure the entrepreneur adopts, he or she will need to pay payroll taxes if any employees are working for the company. Also the entrepreneur will need to collect state and local sales taxes if taxable goods and services are sold, and finally self-employment tax may be applicable. A few states and local jurisdictions may levy additional taxes on LLCs. These taxes may be referred to as franchise tax, LLC tax or business tax, depending on the state.
A Few Final Words
The final difference between the LLC and sole proprietorship lies in paperwork and compliance requirements. The sole proprietorship requires the least amount of paperwork and may only need to renew business permits, if applicable. The LLC has more compliance responsibilities and will need to file an annual report in many states. In order to preserve liability protection of the LLC it is imperative that the paperwork is up to date and is kept in good standing. When it comes to all things business, Incorporation Rocket proves to be a great resource for entrepreneurs.