Sole Proprietorships

The ease that comes with the formation of a sole proprietorship is comforting to most business owners as they are not as legally binding as other business structures. In short, it’s a business handled by a single individual.

If a business has more than one owner, obviously it is not a sole proprietorship. The separation of the business entity is also not disconnected, as you’re already part of the business.

The interesting aspect of a sole proprietorship is that you don’t necessarily have to apply and register in a particular state. You have to file a registration form for other business structures.

And setting up a sole-proprietorship is as simple as it gets. Just select a business name and location. After that, file for a business license in your city and create a separate business account to differentiate between your personal and business expenses.

Should I Start as a Sole Proprietor or LLC?

The decision to choose a legal business structure is something small business owners shouldn’t take lightly.

Advice from tax specialists and business professionals would benefit you in the long-run. Weigh the pros and cons of both business entities and only then decide the course of your business.

To make a clear distinction, let’s dive into key characteristics, advantages, and disadvantages between a sole proprietorship and a limited liability company (LLC), and how to decide which structure is more suitable for your business needs.

The Nature of a Limited Liability Company (LLC)

A limited liability company (LLC) is more of a combination of a partnership and a corporation. You would have to pay registration fees upon filing your business as an LLC in a given state. And usually, a maintenance fee is charged to keep the LLC status.

With a limited liability company (LLC), debts and assets of the company are set aside from your financial image.

The business can transfer the total profit and loss of the business to the owners without taxing the business entity. Furthermore, business owners are also secure from bearing personal liability.

Also, the parties involved in running an LLC are safe from lawsuits. Hence, the name "limited liability."

The Scope of a Limited Liability Company (LLC)

According to business experts, an LLC is the most flexible and efficient form of legal business structure. And the pass-through tax benefits of running an LLC are hard to overlook, which means what is reported on your business tax return flows-through to your personal tax return.  It even allows you to avoid the double taxation imposed by the IRS.

In recent years, LLC has gained popularity because small business owners can take advantage of its benefits in the form of partnership and corporation. Additionally, an LLC business structure is also preferable for small business owners who want to operate outside of the U.S borders without a resident permit.

The formation of an LLC legal structure cuts down most of the bureaucratic complexity. And as a limited liability company, you can have a safe distance from the federal, and state governments.

Possible Hurdles Associated with a Limited Liability Company (LLC)

Although the scope of a limited liability company is advantageous for business owners, there are certain problems business owners may have to face over time.

The owner of an LLC business structure cannot raise investment funds in the form of shares. Furthermore, the expansion of the business becomes an issue because most of the states have a different set of rules that govern LLCs.

Corporations have a distinct advantage over the LLC business structure, as the leadership and chain of employees are easily identifiable. Similarly, the allocation of desired business roles can be tricky as well. Consequently, it makes partners, employees, and customers hard to recognize who’s in charge.

Pros and Cons of Forming a Sole Proprietorship and LLC

The internal factors such as the vision, set goals, and the number of owners will decisively play a role to select your business structure. Therefore, be aware of some of the pros and cons linked with a sole proprietorship and a limited liability company.

Formation of the Company

The formation of the sole proprietorship is much easier as compared to an LLC. Furthermore, the cost of running a sole proprietorship is relatively low. Subsequently, you can acquire licenses and permits without trouble.

The paperwork for an LLC, however, can pile up. And the registration process should be done as per the state’s required guidelines and with city officials.

The owner of the LLC legal entity will also have to file articles of incorporation explaining who runs and makes the decisions of the company. And each state has a filing fee from $100 to $1000.

Cash Flow

For smooth business operations, you need sustainable cash flow. And you can gain funds for sole proprietorship and a limited liability company (LLC) in many ways.

A sole proprietor can gather funds through a line of credit from a bank. It may sound simpler, but owners often have to provide personal collateral to get loans. Alternatively, an LLC owner has access to get funding through the same traditional methods. Owners, however, aren’t inclined to pay debts and financial obligations of the business.

The advantage of forming a limited liability company is that it allows owners legal protection and financial gains to have a stable cash flow for an entire tax year.

Taxation

The taxes for a sole proprietor business owner depend on net business income. That said, the taxes must be filed separately from the owner’s tax return.

The taxation for a limited liability company is applicable in the form of a sole proprietorship, a partnership, or a corporation. However, an LLC falls under the same tax principles as a sole-proprietorship.

And as per 2019, both sole proprietors and LLC owners can benefit from a federal law that allows the pass-through deduction of 20% for net business income.

A sole proprietor also has to pay self-employment taxes on his or her business income. This can sometimes be considered a disadvantage for small business owners.

Operational Costs

The main advantage of running a sole proprietorship is that you can make business decisions on your own with complete freedom. The owner maintains 100% control and ownership of the business and is entitled to the profits of the business.

A limited liability company (LLC) can either have a singular decision maker or multiple owners to share the responsibilities of the business. The approach to share responsibilities among executives is more advantageous and flexible that could ultimately improve the financial growth of the firm.

Liability Factor

The major drawback of running a sole proprietorship is that the financial or legal turmoil always falls on the person running the business. And not to mention the small business owners who function as sole-proprietorships are vulnerable to debs, fines, and possible lawsuits.

A limited liability company (LLC) is essentially a separate business entity. And the owners are protected from the actions of the creditors or possible lawsuits against the business.

The Final Thoughts

It would be wise to seek help from a business expert who can guide you to select the business structure that suits your business model.

You can even compare the experience and legal structure of various small business owners that may have the same target market as yours.

Also, business professionals can give an insight into your financial limitations, logistics issues, taxes, and filing techniques.

And once you have done that, expect to see gradual business growth and new opportunities.

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