Sole Proprietorship vs. LLC: Which Business Structure Is Right for You?

Roughly 73% of all businesses in the United States operate as sole proprietorships, making it the most common business structure by far. Yet every year, millions of entrepreneurs file paperwork to form LLCs instead. What do they know that the majority doesn't?

The answer isn't that one structure is inherently better than the other. Each serves different purposes, protects different interests, and comes with its own set of trade-offs. Choosing between a sole proprietorship and an LLC is one of the most consequential decisions you'll make when starting a business—and making the wrong choice can cost you everything from unnecessary taxes to your personal savings.

This guide breaks down the key differences between sole proprietorships and LLCs, helping you understand which structure aligns with your business goals, risk tolerance, and growth plans.

What Is a Sole Proprietorship?

A sole proprietorship is the simplest and most automatic business structure. If you start freelancing, consulting, or selling products without formally registering a business entity, you're already operating as a sole proprietor. There's no separation between you and your business—legally, you are the business.

How Sole Proprietorships Work

When you operate as a sole proprietor:

• No formal registration required: You can start immediately without filing paperwork with your state (though you may need local business licenses or permits)
• No separate legal entity: Your business doesn't exist as a distinct entity from you personally
• Pass-through taxation: All business income flows directly to your personal tax return via Schedule C
• Complete control: You make all decisions without consulting partners or boards

For tax purposes, sole proprietors report business income and expenses on Schedule C of their Form 1040. You'll also pay self-employment tax (currently 15.3%) on net earnings to cover Social Security and Medicare contributions.

What Is an LLC?

A Limited Liability Company (LLC) is a formal business structure that creates a separate legal entity from its owners (called "members"). Forming an LLC requires filing articles of organization with your state and paying associated fees.

How LLCs Work

When you operate as an LLC:

• Formal registration required: You must file formation documents with your state
• Separate legal entity: The LLC exists independently from its members
• Liability protection: Members' personal assets are generally shielded from business debts and lawsuits
• Flexible taxation: By default, single-member LLCs are taxed like sole proprietorships, but you can elect S-corp or C-corp taxation

Single-member LLCs are treated as "disregarded entities" for federal tax purposes, meaning they file the same Schedule C as sole proprietors. However, the legal separation between owner and business remains intact for liability purposes.

Key Differences at a Glance

Factor	Sole Proprietorship	LLC
Formation	Automatic, no filing required	Requires state filing and fees
Cost to Start	$0 (plus any local licenses)	$35-$500 depending on state
Liability Protection	None	Personal assets protected
Taxation	Pass-through (Schedule C)	Pass-through by default, flexible options
Ongoing Requirements	Minimal	Annual reports, fees in most states
Credibility	Informal	More professional appearance
Ownership	Single owner only	Single or multiple members

Liability Protection: The Critical Difference

The most significant difference between these structures is liability protection—and it's not just theoretical.

The Sole Proprietorship Risk

As a sole proprietor, you and your business are legally the same entity. This means:

• If your business is sued, you're personally sued
• Business debts become your personal debts
• Creditors can pursue your personal assets—home, car, savings, retirement accounts—to satisfy business obligations
• A single lawsuit or business failure could wipe out everything you own

Consider a consultant whose client claims professional negligence caused significant financial harm. As a sole proprietor, the consultant's personal assets—including their family home—could be seized to pay damages.

The LLC Shield

An LLC creates a legal wall between your business and personal assets. When properly maintained:

• Lawsuits against the business don't automatically reach your personal assets
• Business debts stay with the business
• Your home, personal savings, and retirement accounts are generally protected

The key phrase is "properly maintained." To preserve liability protection, you must:

• Keep business and personal finances completely separate
• Maintain adequate business insurance
• Follow all state compliance requirements
• Avoid commingling funds or treating the LLC as your personal bank account

If you pierce this "corporate veil" through sloppy practices, courts may disregard the LLC's protection and hold you personally liable anyway.

Formation Requirements and Costs

Starting a Sole Proprietorship

Starting a sole proprietorship costs essentially nothing in terms of formal business registration. You may need:

• Business license: Required in many cities and counties, typically $25-$100
• DBA (Doing Business As): If operating under a name other than your own, $10-$150 depending on location
• Professional licenses: Industry-specific requirements vary

That's it. You can be in business today with minimal paperwork.

Forming an LLC

LLC formation involves more steps and costs:

• State filing fee: Ranges from $35 (Montana) to $500 (Massachusetts), with a national average around $130
• Operating agreement: While not required in all states, highly recommended to document ownership and operations
• Registered agent: Required in all states, either yourself or a service ($100-$300/year)
• Annual report fees: Most states require annual filings, averaging $91 per year
• Potential franchise taxes: Some states charge additional taxes on LLCs

Special note for New York: LLCs must publish formation notices in two newspapers for six weeks, adding $600-$2,000 to startup costs.

Tax Implications

Both structures offer pass-through taxation by default, meaning business income passes through to your personal return without entity-level taxation. However, there are important nuances.

Sole Proprietorship Taxes

• All net income reported on Schedule C
• Subject to self-employment tax (15.3%) on net earnings
• No flexibility to change tax treatment

LLC Tax Options

Single-member LLCs have more choices:

• Default (disregarded entity): Taxed identically to sole proprietorship
• S-corp election: Can reduce self-employment taxes on owner distributions once income exceeds roughly $50,000-$75,000 annually
• C-corp election: Rarely beneficial for small businesses but available

Multi-member LLCs file partnership returns (Form 1065) by default, with each member receiving Schedule K-1 forms showing their share of income.

State Tax Considerations

Some states impose additional taxes on LLCs that sole proprietorships don't face:

• California: $800 minimum franchise tax annually
• Texas: Franchise tax on LLCs exceeding $1.23 million in revenue
• Delaware: $300 annual LLC tax

Factor these costs into your decision, especially if operating in high-tax states.

When to Choose a Sole Proprietorship

A sole proprietorship makes sense when:

Low Risk, Low Revenue

If your business has minimal liability exposure and modest income, the simplicity of a sole proprietorship may outweigh the benefits of an LLC. Consider this structure if:

• You're testing a business idea before committing
• Annual revenue is under $40,000-$50,000
• You don't have significant personal assets to protect
• Your work doesn't involve high-risk activities

Service-Based, Low-Liability Work

Certain industries carry inherently lower liability:

• Freelance writing, editing, or design
• Virtual assistance
• Tutoring or coaching (without physical contact)
• Consulting in low-risk fields

Side Hustles and Hobby Businesses

If you're earning supplemental income without building a scalable business, sole proprietorship keeps things simple. You can always convert to an LLC later if the business grows.

When to Choose an LLC

An LLC becomes the better choice when:

You Have Assets to Protect

If you own a home, have significant savings, or have built retirement accounts, an LLC helps shield those assets from business liabilities. The protection is especially valuable once your net worth exceeds what you could afford to lose.

Your Business Carries Risk

Higher-risk activities warrant formal liability protection:

• Construction, manufacturing, or physical services
• Retail with physical products (product liability)
• Food service
• Healthcare or professional services
• Any business with employees
• Businesses using vehicles or equipment

You Want to Build Credibility

An LLC signals legitimacy to:

• Potential clients, especially enterprise or government customers
• Banks and lenders evaluating loan applications
• Investors considering funding your business
• Partners and vendors assessing business relationships

You Plan to Grow

If you envision scaling beyond a solo operation, LLC structure provides:

• Ability to add partners or investors
• Clearer succession planning
• Easier business sale if you eventually exit
• Tax optimization options as income grows

Converting from Sole Proprietorship to LLC

Many entrepreneurs start as sole proprietors and convert to LLCs as their businesses grow. Signs it's time to convert include:

• Increasing revenue and profitability
• Plans to hire employees
• Need for outside investment or loans
• Growing personal assets worth protecting
• Expanding into higher-risk activities

The conversion process typically involves:

1. Filing articles of organization with your state
2. Obtaining a new EIN (if the LLC will have employees or multiple members)
3. Opening business bank accounts in the LLC's name
4. Updating contracts, licenses, and vendor relationships
5. Transferring assets from personal ownership to the LLC

Consider timing this conversion at the start of a calendar year to simplify tax reporting and avoid filing returns for two entity types in the same year.

Common Mistakes to Avoid

Choosing Solely Based on Cost

While sole proprietorships cost less to start, the wrong structure can cost far more in the long run. A single lawsuit that reaches your personal assets dwarfs any LLC filing fees.

Assuming an LLC Guarantees Protection

LLC protection isn't automatic or absolute. You must:

• Maintain separate business accounts
• Keep adequate business insurance
• Follow corporate formalities
• Meet all state compliance requirements

Ignoring State-Specific Rules

LLC costs, requirements, and tax treatment vary significantly by state. Research your specific state's rules rather than relying on general guidance.

Delaying the Decision Too Long

Operating as a sole proprietor "temporarily" while building the business means operating without liability protection during a high-risk growth phase. If you know you'll eventually want an LLC, consider starting with one.

Making Your Decision

The right choice depends on your specific circumstances:

Choose sole proprietorship if: You're starting small, testing ideas, have minimal assets to protect, and operate in a low-risk industry.

Choose LLC if: You have personal assets worth protecting, operate in a higher-risk industry, plan to scale, need credibility with clients or lenders, or want tax flexibility as income grows.

When in doubt, consult with an attorney or accountant who can evaluate your specific situation. The cost of professional advice is minimal compared to the cost of choosing the wrong structure.

Track Your Business Finances from Day One

Regardless of which structure you choose, maintaining clear financial records is essential. Good bookkeeping helps you understand profitability, prepare for taxes, and demonstrates financial discipline to lenders or investors. Beancount.io offers plain-text accounting that gives you complete transparency and control over your financial data—with version-controlled records that grow with your business from sole proprietorship to LLC and beyond. Get started for free and build the financial foundation your business needs.