Deciding between a limited liability company (LLC) and a sole proprietorship can be confusing for someone starting a new business. While there are pros and cons to each, if you are willing to put in the initial paperwork and fees, an LLC is the better way to go. Here’s why.
A sole proprietorship is the simplest way to start a business. Basically, you just begin. The official definition of a sole proprietorship from Merriam-Webster is, “a business owned and controlled by one person who is solely liable for its obligations.”
Now, if you want to name your business something other than your name, you do have to file a form called a DBA. This stands for “Doing Business As” and is relatively inexpensive and simple.
Taxes are also easy. You claim all the profits and losses of the business on your individual tax return. There is no need for a separate return.
However, there is absolutely no liability protection as a sole proprietor. If someone decides to sue you, the can go after all of your assets—even ones not directly linked to the business, such as your home, auto, and other assets.
Limited Liability Company (LLC)
On the other hand, a limited liability company (LLC) gives a business owner protection from any liabilities. Yes, the business can still get sued, but only the business assets are in danger, not your personal property.
If there is only one owner, then a single-member LLC is the way to go. The profits and losses are still calculated through the individual’s own tax return.
However, the beginning of an LLC is not as simple as the sole proprietorship. An LLC is a “statutory entity,” which means that the state that issues the certificate of formation sees the business as a separate person. In order to receive this type of certification, the business owner will have to pay filing fees to obtain a certificate of formation. Normally, each state has direction on how to file on their state web site.
Additionally, if partners are ever added to the business, the LLC can absorb these new investors, but a separate tax return will need to be filed for the business and you will lose your profits and losses from your individual tax return.
Deciding on which form for your new business to take on initially comes down to two factors: the liability factor and the cost of starting an LLC. If you feel that your products will not leave you open to a potential lawsuit, then just start doing business as a sole proprietor. However, if you feel that you could, in any way, shape, or form, be open to a potential lawsuit, or if you feel that you may one day be adding partners or investors, an LLC gives you the best options for incorporating in the future.