Sole Proprietor vs. LLC: How Your Taxes Will Change
Over 75% of small businesses in the United States operate as sole proprietorships. This means that your business has a single owner – you – and that all risks and liabilities are taken on by you and no one else.
Remaining a sole proprietorship is a great choice for companies that are not interested in huge growth or in sharing decision-making with partners or a board of directors. If, however, your business is growing and you’re thinking of becoming an LLC, it’s important to know how your tax responsibilities and incentives will change.
For many small businesses, a sole proprietorship is the best setup in the beginning. It’s the least expensive in terms of taxes and fees, and it’s the simplest in terms of paperwork and tax forms. If you own your business, have a handful of employees or no employees at all, and aren’t generating a lot of income, staying a sole proprietor is probably your best bet for the time being.
When operating as a sole proprietor, your business’s taxes are directly linked to your personal taxes. You assume full liability for all of your personal assets, and if your company is sued, your house and car can be seized by the court for payment.
Limited Liability Corporation
When your business starts to grow in terms of revenue and employees, it may be time to make the leap to LLC. Like sole proprietorships, LLCs are often owned by a single person, but enjoy more protection and tax benefits. By becoming an LLC, your personal taxes are separated from your business’s taxes, in the sense that your personal assets are no longer at risk if you are sued.
LLCs enjoy better tax rates and the opportunity for investors and partners to invest in the company. Taxes are still linked to the owner’s personal taxes if the LLC is operated by a single person, but the owner is no longer liable for debts taken on by the business entity.
In many states, the fees to operate as an LLC increase considerably when making the move from a sole proprietorship. The forms and fees paid to a tax professional also increase considerably as the business grows. If you paid your accountant $300 to file your taxes as an independent contractor, you could end up paying $1,000 as an LLC or $2,000 as a corporation.
Which is right for you?
Timing is essential when determining which type of business entity is right for you. Just because other business owners you know have created LLCs doesn’t mean you need to rush into incorporation. It is possible to run a business as a sole proprietor for as long as as makes sense for you and your company.
If your business begins to grow, the first thing to do is contact your tax professional and do as much research as possible on what it would mean to become an LLC in your home state. The decision to grow your business is an important one that is very personal and very dependent upon individual circumstances. Give yourself ample time to weigh the pros, cons and necessary financial commitments before making the leap to LLC.