LLC vs. sole proprietorship: which one should I choose?

What is an LLC?

A limited liability company, or LLC, is a very popular American structure that provides limited liability and tax transparency.

With an LLC, members are not personally liable for the company's debts, thus protecting their personal assets from being used to cover them should something go wrong.

In turn, the benefits and losses of the LLC are transferred directly to the owners, who report these movements on their personal tax returns.

This type of organization is very popular in the United States because it also entails low opening and maintenance costs, high privacy and great operational versatility.

Finally, LLCs can have several owners, or only one in the case of LLC sole proprietors.

What is a sole proprietorship?

For its part, a sole proprietorship or sole proprietorship consists of a business structure where the owner is the legal entity and solely responsible for all business operations.

In this case, there is no separation between personal and business assets, which means that the owner is personally responsible for the debts and obligations of the company.

A key characteristic of a sole proprietorship is that it can only have one owner; If a partner is added, it becomes a general partnership. It is especially popular among freelancers and consultants who want to simplify tax filing.

LLC vs. sole proprietorship: complete comparison

The decision to choose to create an LLC or a sole proprietorship to do business in the United States and the rest of the world will depend on each particular case, but their differences must always be taken into account:

Personal responsibility

In a sole proprietorship, there is no legal separation between the business and the owner, which means that the owner is personally responsible for business debts.

In the event of bankruptcy, the owner must file for personal bankruptcy, including both personal and business debts. In addition, those who sue the company can personally approach the owner and his assets.

In contrast, in an LLC, the partner is separated from business obligations, so if the business fails, the members do not have to cover the debts with their resources, except in cases of fraud, negligence or individual secured debts.

Taxes

On the other hand, a single-member LLC and a sole proprietorship have the same tax treatment, being pass-through entities without corporate taxes.

This means that the owners report the income on their personal tax return and pay taxes at the income rate

At the same time, in addition to income taxes, both structures may have additional tax obligations, such as payroll and sales taxes.

Business opening and maintenance costs

As for costs, opening a sole proprietorship is a free process, while creating a sole proprietorship LLC involves an expense, which will depend on the state in which the LLC is registered.

Likewise, limited liability companies usually require an annual fee, as well as other expenses linked to certain necessary documents to operate legally in the United States.

In any case, it must be taken into account that the costs of an LLC are usually not excessive: any small businessman or independent worker will be able to cope with them without any problem.

Company management

A sole proprietorship is characterized by requiring simple management, since a single owner makes decisions without the intervention of third parties. Although you can hire help, your primary responsibility is to ensure the operation and profitability of the business. 

In contrast, an LLC is slightly more complex, with a structure detailed in an operating agreement, a document that describes the ownership, voting rights and profit sharing of members. If it is a sole proprietorship, it is almost identical to a sole proprietorship.

In the case of LLCs, decisions and profits are usually based on the proportion of ownership of each member. For example, a 25% owner of the business has a quarter of the votes and profits, adding an extra layer of organization and responsibility compared to a sole proprietorship.

Responsibilities and obligations

Finally, there is a big difference between an LLC and a sole proprietorship in terms of paperwork and compliance requirements.

A sole proprietorship involves little initial paperwork and focuses on tax compliance. An LLC, on the other hand, has more responsibilities because it must file annual reports, draft Operating Agreements, and manage ownership.

These steps are not required, but are recommended to preserve liability protection. Additionally, dissolving an LLC involves additional paperwork.

Which one should I choose?

The choice between opening an LLC or creating a sole proprietorship will depend on each particular case: not all entrepreneurs or independent workers have the same characteristics, objectives and needs.

However, although a sole proprietorship is cheaper and offers much simpler management, it does not provide the limited liability protection of an LLC.

Initially, when a project is born, choosing between one or the other structure may seem almost indifferent. But,as the business, whatever it may be, grows, the LLC becomes a more effective option in different areas.

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