Choosing between an LLC and a sole proprietorship is one of the first decisions you’ll make as a US business owner. Both are simple compared with a corporation. The big differences are personal liability protection, cost and paperwork.
This article is general information, not legal or tax advice. Rules vary by state, so check with an accountant or attorney before you decide.
Quick comparison
| Sole proprietorship | LLC (limited liability company) | |
|---|---|---|
| Setup | Automatic when you start doing business alone | File articles of organization with your state |
| Cost to form | Little or nothing (maybe a DBA and local licences) | State filing fee, often roughly $50–$500, plus some annual fees |
| Personal liability | You’re personally liable for business debts and lawsuits | Generally protects personal assets from business debts |
| Taxes | Profit taxed on your personal return (Schedule C) | Single-member LLC taxed the same by default; can elect S-corp tax |
| Self-employment tax | On all net profit | On all net profit by default; S-corp election can reduce it |
| Paperwork | Minimal | Annual reports and fees in most states; operating agreement recommended |
| Credibility | Fine for freelancers | Often looks more established to clients and banks |
| Owners | One | One or more (members) |
What is a sole proprietorship?
A sole proprietorship is a business owned and run by one person, with no legal separation between you and the business. If you freelance or sell something on your own without forming an entity, you’re already one.
Pros
- No formation filing in most states
- Lowest cost and simplest records
- Easy to start and easy to close
Cons
- Unlimited personal liability: creditors or someone suing the business can go after your personal assets
- Harder to raise money or add partners
- Can look less established to some clients
What is an LLC?
An LLC is a separate legal entity formed under state law. It separates your personal assets from the business, while keeping taxes simple.
Pros
- Limited liability protection for your personal assets, if you keep business and personal finances separate
- Flexible taxes: default pass-through, or elect S-corp taxation to potentially reduce self-employment tax once profits are higher
- Can have multiple owners
- Often looks more credible to clients, banks and partners
Cons
- Formation fees and annual state fees (some states charge much more than others)
- More paperwork: annual reports, registered agent, operating agreement
- Liability protection can be lost if you mix personal and business money
How taxes work for each
Both are “pass-through” by default. The business doesn’t pay federal income tax itself. Profit flows to your personal return.
- Sole proprietor: report profit on Schedule C and pay income tax plus self-employment tax (Social Security and Medicare) on net earnings.
- Single-member LLC: taxed exactly like a sole proprietorship by default.
- LLC electing S-corp status: you pay yourself a reasonable salary through payroll, and remaining profit can be taken as distributions that aren’t subject to self-employment tax. This usually only makes sense once profits are high enough to cover the extra payroll and accounting costs. Ask an accountant where that point is for you.
When a sole proprietorship makes sense
- You’re testing an idea or freelancing part-time
- Your work carries low liability risk
- You want the lowest cost and least admin
When to choose an LLC
- You have clients, contracts, employees or inventory that create liability risk
- You plan to grow, add a partner or open business credit
- Your profits are growing and an S-corp election could save tax
- You want a more established image
Many people start as sole proprietors and form an LLC once the business is earning steadily.
How to form an LLC (basic steps)
- Choose a business name that’s available in your state.
- Appoint a registered agent.
- File articles of organization with your state and pay the fee.
- Write an operating agreement, even if you’re the only member.
- Get an EIN from the IRS (free).
- Open a separate business bank account.
- Check state and local licences, and diary your annual report deadlines.
For more on the legal side, read our legal considerations when setting up an LLC. If you’re starting with a co-founder, also see the founders’ agreement: what it is and why you need it. Keep your books clean from day one with our small business bookkeeping tips.
FAQ
Is it better to be an LLC or a sole proprietor?
An LLC is usually better if your business has real liability risk or is growing, because it protects personal assets. A sole proprietorship is fine for low-risk, early-stage or side businesses where simplicity matters most.
What are the disadvantages of an LLC?
Formation and annual fees, more paperwork, and in some states high annual taxes. Liability protection can also be lost if you don’t keep business and personal finances separate.
What is a one-person LLC called?
A single-member LLC. By default, the IRS treats it as a “disregarded entity,” so it’s taxed like a sole proprietorship.
Can I switch from a sole proprietorship to an LLC later?
Yes. You form the LLC with your state, get a new EIN if needed, and move contracts, bank accounts and licences into the LLC’s name.
