Should you set up as a Sole Proprietorship or an LLC?

Chances are, you have at least heard the terms sole proprietorship and limited liability company, better known as LLC.  However, you may not really know what the differences are between these two things or how they can affect you directly.  The truth is, even many people that are aspiring business owners are not fully aware of the differences between the two.  This often makes it difficult to set up a business and be fully aware of what you are getting yourself into.  Having a solid understanding of the two can benefit you in several ways.  For example, it helps you better understand when one or the other is used to operate a business.  It also helps you gain a better understanding of the process required to set both of them up, as well as the advantages and disadvantages of each.  In short, it gives you the power to decide how you want to set up a company without wondering whether or not you have made a major mistake right off the bat.

What is a sole proprietorship?

In short, it all has to do with the way that taxes are taken out for your business.  The sooner that you understand that this is the reason that you must declare either a sole proprietorship, an LLC or some other type of designation is directly related to the way that you are taxed, the sooner that you will be able to understand why these designations are so important.  A sole proprietorship is one of the easiest forms of businesses to set up. In fact, it requires very little effort on your part.  Typically, there are two ways that you can go about setting up a business in this fashion.  You can either declare your business as a sole proprietorship on a tax form and you are then taxed accordingly, or you can simply declare it as such income when you do your income taxes.  For example, you will have to choose this designation if you serve as an independent contractor for anyone and you are doing that as your primary source of income.  If you work from home as a consultant for another business, yet you are not directly employed by that business, then you essentially have a sole proprietorship.  You will be taxed as such by the company that you are associated with at tax time.  On the other hand, you may be selling items out of your own home.  You are not associated with anyone directly but you will get tax statements in the mail from the companies that you have sold through.  If you are involved in direct sales to the customer and they do not involve any other companies, you will be responsible for declaring a sole proprietorship on your own taxes and then allowing the correct amount of taxes to be taken out.

When is a sole proprietorship used?

More often than not, it is used when there is only a single individual that is running a business and you have no plans to expand. This is especially true if you are just starting out.  You can use this type of designation to test the waters, so to speak.  If your business grows, you may want to switch it to an LLC later on but in many cases, you can leave it as a sole proprietorship if that is working well for you.  The great thing about it is that you can make the decision to start a business of your own, choose this tax designation and start making money right away.  There is no complicated paperwork that you have to go through so you do not have to wait for a long period of time before you can start doing something to put yourself in a better financial situation.

Setting up as a Sole Proprietor

As previously mentioned, there is really not that much that is required to accomplish this goal.  In reality, it is more about checking a box on a piece of paper and then ensuring that your taxes are done correctly than anything else.  The great thing about setting up as a sole proprietor is that you can usually include your business taxes on your personal tax return as opposed to having to file quarterly taxes.  Of course, there are exceptions.  If you find yourself in a situation where you are making far more money than you expected to make, you may have to start filing taxes quarterly in order to reduce the amount that you owe on a yearly basis.  This is especially true if you start out filing yearly and find yourself in a position where you are unable to pay the full amount without setting up a payment plan.  You will be able to set up a payment plan, but you may be required to pay taxes quarterly after the point in order to ensure that you can more easily make the payments in full.  However, if you have a side business and you only need to make a little extra money each month, you can typically roll this over onto your personal taxes and file a single tax return without having to deal of all the hassle of quarterly returns or filing separate business taxes.

Sole proprietorship vs LLC

When you consider an llc vs sole proprietorship, it is important to recognize the biggest differences between the two.  There are some advantages to setting up a company as an LLC and in some cases, you will not be able to set it up as a sole proprietorship so you will be forced to do so.  For instance, your designation can be affected by the number of employees that you have when it occurs under the right circumstances.  If any of those employees actually become a partner in your business, you can no longer list the business as a sole proprietorship.  In addition, you can set up the way that you wish to pay your taxes with an LLC.  It gives you a little bit more control and allows you to decide how you want to go about the entire process.  Furthermore, an LLC gives you all the same protection that your business would get if you set it up as a corporation, yet you can enjoy these advantages with a very small business that does not meet the criteria for a corporation.

What does it all mean?

Basically, you will have to decide for yourself which option is right for you.  If you have never had any experience owning a business of your own in the past, your best bet is probably to set up as a sole proprietor and then expand from there.  As you learn more about the way that a business works and find out whether or not owning a business is really for you, you can then decide to change it to an LLC when the time is right.  Much of it will depend on the particular business in question as well as the amount of money that you make each year.