When starting a new business, when deciding the business structure, especially for a business with a sole owner or just a few employees, there are basically two options:
- Sole Proprietorship
- Single Member Limited Liability Company (LLC)
There are three main reasons to choose to become a Single Member LLC: personal liability, income tax treatment, and ongoing business compliance. Let’s compare each in order to understand which is best for your new business.
A business owned by a single individual is automatically considered a sole proprietorship. If a person uses their name in the company title, there is no need to register the business name with the state. However, if they give the company a name that does not include their name, they will more than likely have to register with the state.
Single Member LLC
A single member LLC can be formed by a sole proprietor by filing the proper paperwork with the state. So why bother? As a single member LLC, the business is seen as a separate entity. Therefore, the business is responsible for debts or accepts lawsuits. Many sole proprietors opt to become a single member LLC for the particular reason of protecting of personal assets.
As a sole proprietor, there is no legal separation between an owner’s assets and business assets. Therefore, if there are any debts that are owed, the owner can get sued and have to sell off their own personal property to satisfy the debt. In addition, if there is a lawsuit, the plaintiff can go after the sole proprietor’s personal property. With a single member LLC, the business is seen as its own separate entity and any assets owned or debts owed stop where the business ends. It doesn’t “spill over” into the owner’s personal life.
The treatment of income tax is an important part of choosing a single member LLC. Since the IRS looks at this type of business as a separate entity, the tax obligations also flow through the business. In addition, the way that income is taxed can mean a higher tax rate if not filed as an S-Corporation, only available when a business is a single member, LLC.
This is the one instance where being a sole proprietor can have an advantage over a single member LLC. The administrative ease for a sole proprietorship is in the amount of paperwork and corporate compliance issue to deal with versus the annual filing, separate bank accounts, and recording of major changes. Since a sole proprietorship is not seen as a separate entity, there may not be a need to keep up with compliance issues or separate form.
When considering the big picture, experts advise on filling out the extra paperwork to become a single member LLC.