In today's video, we're going to be talking about sole proprietorship vs LLC, and helping you decide which is best for your business.
If you're just starting your online business and you're not sure whether a sole proprietorship is right for you or an LLC is right for you, or something else entirely, then stay tuned. I will help you consider factors that will help you decide what type of business entity you should be choosing for your online business. So when you're weighing the differences between a sole proprietorship and an LLC, there are five main distinctions between the two that you need to consider when you're deciding which to choose. We're going to take those one at a time and we're going to break them all down for you right here.
Sole Proprietorship vs LLC #1 Consideration – Limited Liability
So let's start with the first consideration, limited liability. One of the main benefits of an LLC over a sole proprietorship is that it affords the owner of the business what's called limited liability. This means that when it comes to the debts and obligations of the business, or let's say the business gets sued, the owner has limited liability with regard to those legal obligations. On the other hand, a sole proprietorship or a sole proprietor has no such legal protection. The debts of the business when it's a sole proprietorship are the same as the debts of the owner of the business. So if the business gets sued, the owner gets sued. There is no distinction between the two and the owner's personal assets can actually be used to pay the debts of the business if something like that were to happen.
So this is one of the main, if not the main benefit of forming an LLC is that it affords the owner of the LLC called a member, when we're talking about an LLC's what is called limited liability, meaning that they cannot be held personally responsible for the debts and obligations of the business. So when we're looking at that first consideration, it definitely weighs heavily in favor of forming a limited liability company, because honestly, who wants to be responsible for the debts of the business? Nobody.
Sole Proprietorship vs LLC #2 Consideration – Startup Expenses
Number two, startup expenses. This one's pretty simple. A sole proprietorship has no startup expenses, legal expenses that is. It's that easy. There might be some small startup expenses. You might need to file what's called a DBA or a doing business as, or a trade name with your secretary of state in the state where you're going to be operating the business. You may have to apply for and get some licenses to operate your business wherever you're located. But other than that, you don't need anything else to form a sole proprietorship. You don't need any contracts. You don't need to file anything with the state and anything like that. It's really simple. You basically start doing business and you're in business. That's it. An LLC on the other hand can run anywhere from several hundred dollars to several thousand dollars, depending on whether or not you hire a lawyer, you do it yourself, you hire another service like incfile.com.
Here's an affiliate link to the service that I recommend if you're looking to form an LLC. Or if you want to do it yourself, that's something you can do too. But there's a lot of tricks and traps and things that you might need to be concerned about. So when we're looking at startup expenses, that's definitely going to weigh in favor of the sole proprietorship because it's cheap.
Sole Proprietorship vs LLC #3 Consideration – Corporate Formalities
Number three, corporate formalities. In number one we talked about how an LLC or a limited liability company enjoys limited liability. But there's a big catch. You only get the limited liability if you follow the appropriate corporate formalities. Failure to file those corporate formalities, such as failing to have an operating agreement in place that you follow, keeping notes on meetings of the business, also called minutes or following the other requisite corporate formalities of having an LLC will allow a creditor of the LLC to do what's called piercing the corporate veil. And that basically eliminates all the limited liability benefits that come with an LLC. A sole proprietorship on the other hand has no such corporate formalities to follow. And that's because, well, you don't have any limited liability so there's nothing you need to worry about there. So if you're in this sticky spot where you think you need the limited liability but you're not sure that you are able to manage the corporate formalities that come with maintaining an LLC, you really have two options.
Number one, you don't waste your time filing the LLC. You're just spending a lot of money and then you're not really going get the benefit of it. I know a lot of people who will file articles of organization and form an LLC with the state, and they're like, “Oh yeah, we've got this LLC but they followed none of the corporate formalities.” In which case it's not doing them a hill of beans. Does that make sense? Probably not. On the other hand, you can hire a lawyer to help you and a lawyer is great because they will make sure you stay on track. They will make sure you don't miss any deadlines and you have the appropriate agreements and documents in place. They will also make sure you do all the proper filings. And they'll stay up to date with you on, usually a quarterly basis to make sure that everything is going okay with the business and you're not making any decisions without consulting with your business partners or the operating agreement. And these are decisions that you really need to think about when you're deciding whether or not an LLC is appropriate for you or whether or not you want to stay a sole proprietorship.
Sole Proprietorship vs LLC #4 Consideration – Taxes
Number four, taxes. I love me some taxes. See I'm going this way, that means I don't really like the taxes. If you're a sole proprietorship, you're going to keep track of all your income and your expenses and you're going to report them on schedule C of your Form 1040. Interestingly enough, if you're an LLC, you're going to do the exact same thing, except on schedule C instead of saying the DBA of your business, you're going to say the LLC. And in both cases, you're responsible for paying 15.3% self-employment tax to the IRS in addition to any other income taxes that you would have to pay on your return. If you're confused by this, I've got some videos that talk about the tax aspects of forming an LLC. You might want to check those out. Now, I will say one of the major benefits of forming an LLC is that you can elect to be taxed as an S corporation.
I've talked about this difference before, and in that situation you can elect to pay yourself a reasonable salary, then you only have to pay the self-employment taxes on the amount over and above that salary that you pay yourself as a dividend. And that money is just taxed at your marginal tax rate. So that is a benefit of forming an LLC if you decide to elect S corporation tax status. I realize that was a whole lot of mumbo jumbo, probably went straight over a lot of your heads.
Sole Proprietorship vs LLC #5 Consideration – Protection from Personal Debts
Numero cinco, protection from personal debts. We talked a little while back about how a limited liability company affords you limited liability protection so that you are not personally responsible for the debts of the business. A big benefit to the LLC is that this also goes the other way. The business is not responsible for your personal debts. Times like this it'd really be helpful if I was at home where I could use my kids matchbox pars, but we're going to use these as matchbox cars. Let's say you're driving this car and let's say someone else's driving this car, and let's say that you're not paying attention to what you're doing and maybe you fall at the wheel and you drive and drive and drive and… You caused a big accident. And let's say it was your fault. And you were doing this off business hours so you weren't doing it as the business owner. If you get sued personally for that, an LLC is protected. In other words, the person that sues you personally, they can't get at all the assets of your LLC. Does that make sense? It's a pretty cool benefit if think about it.
So if you're operating as a sole proprietorship, all the assets of the business are fair game to that person that was driving that little car that you hit. So in other words, that limited liability that we talked about at the very beginning, it goes both ways and that is a really cool benefit for somebody who's operating a business. At least I think it's pretty cool. You think it's pretty cool? They think it's pretty cool too. So now you know the main differences between LLCs and sole proprietorships. Benefit to you, I've written a short one page cheat sheet that explains all these differences and many more. There's going to be a link down below in the description. This is a cheat sheet that's going to help you decide for yourself which might be a better option for you, whether you should stay a sole proprietor or whether you should consider forming an LLC. And there might be some other options in there as well that are in the cheat seat, so you want to check that out.
Also, if you want to join a community of online entrepreneurs just like you, I have a secret Facebook community where I share even more legal tips and tricks to help keep your online business protected and profitable. Also, if you think you know some other fellow entrepreneurs in groups you're in or courses or things like that and you think that they would find this helpful, we'd really appreciate if you would share it with them. If you're looking for more information on LLCs and sole proprietorships and taxes and all that fun jazz, here's a playlist that you can check out that'll give you even more fun, stay up late, watching on a Friday night type of videos. Thanks so much. Have a great day folks.