Illinois LLC vs. Sole Proprietorship

There are many ways to organize your business in Illinois. These structures include sole proprietorships, general and limited partnerships, limited liability partnerships, limited liability companies, and “s” and “c” corporations. Some of the most popular business structures for small and new business owners are the sole proprietorship model and LLCs. Understanding the fees, benefits, operating agreement, requirements, taxes, annual report obligations, and options like single member LLC or anonymous LLC, as well as the asset protection they provide is important.

Both structures offer distinct advantages and disadvantages, making the choice of business structure a significant decision when starting your own venture. In this article, we will cover the intricacies of forming an LLC versus operating as a sole proprietorship in Illinois, providing entrepreneurs with the insights needed to make informed decisions aligned with their business goals and circumstances.

An LLC is established in Illinois when you file for one with the Secretary of State. Once your application is approved, Illinois will then recognize your business entity as legally separate from you. This has a few important implications that will be discussed further below. However, an important advantage for LLC owners is that they will no longer be held personally liable for the debts and liabilities of the company.

LLCs offer several advantages, including tax savings, liability protection, privacy (if formed anonymously), increased credibility, and more tax flexibility. One drawback is that there is added complexity when compared to a sole proprietorship for these added options to running your company. See below for a list of the advantages and disadvantages of an LLC.

Advantages:

1. Owners have a lot of flexibility with how to manage and organize their LLCs. Members can organize their company in almost any way they want as long as it is within the confines of Illinois’ regulations. This includes choosing to have the company managed by its members or appointed members.
2. LLCs have several options on how to handle their taxes. One option for taxation includes pass-through taxation, similar to how you would file your taxes if you were running a sole proprietorship. Pass-through taxation is where individual members report LLC profits on their own income tax returns. More information on taxation options is available below.
3. There are fewer regulations for LLCs than for corporations.
4. There is no limit on who can be or how many members the LLC has. In Illinois, it is also relatively easy to file paperwork to transfer ownership and change members of your LLC. You can do so on the Illinois Secretary of State website.

Disadvantages:

1. With all the options available for LLCs, it can be tricky to determine which are the best options for your LLC.
2. There are increased costs associated with establishing an LLC compared to sole proprietorships. In Illinois, there is a $150 filing fee when submitting the articles of organization, an important document required when forming your LLC. However, the benefit compared to many other states is that Illinois refunds this fee if your application were to be rejected for whatever reason.
3. Regulations and tax/ liability treatment can vary amongst the different states. It can increase the complexity of running an LLC. Illinois’ Secretary of State provides a guide to navigating their LLC application and maintenance procedures on their website.

A sole proprietorship, also referred to as a sole trader or a proprietorship, is an unincorporated business with just one owner who pays personal income tax on profits earned from the business. Most small businesses start off as sole proprietorships. It is the most straightforward type of structure to run your business. The business is treated as an extension of the owner. In other words, unlike LLCs, no legal distinction is made between the owner and the business. There are no necessary steps or documents you need to submit when operating a sole proprietorship.

Nonetheless, many people submit a “doing business as” request with their local county clerk’s office and obtain a Certificate of Assumed Name to take on an assumed name such as “Sprinkles and Cakes.” Without this certificate, the sole proprietorship must operate under the owner’s name, for instance, “Jackie’s Cupcakes.” Under the Assumed Name Act, Illinois requires sole proprietors to register with their local county clerk’s office if the business name is different from the owner’s full legal name. Illinois’ county clerks can be found at the web address https://www.iaccr.net/MemberCountiesMain.html.

There are several advantages to owning a sole proprietorship compared to other business structures, including convenience and simplicity. Unfortunately, with the convenience and simplicity, you may make yourself more susceptible to certain financial risks, especially as your business grows. Below is a list of the advantages and disadvantages of a sole proprietorship.

Advantages:

1. Straightforward and low costs to establish than compared to an LLC
2. Minimal maintenance costs
3. Owners have freedom and control over their business decisions within Illinois’ legal limitations.
4. Business profits go directly to the owner. As a result, taxation is simpler. The owner can file their personal tax return and not worry about taxation at the business level.
5. It is straightforward to convert a sole proprietorship to a different business structure. This can be helpful once the company grows and the owner desires protection from personal liability for the business’s debts or obligations.

Disadvantages:

1. Sole proprietorship owners have direct liability for all the debts against the business. In other words, when a person successfully sues your business, the business and your personal assets, may be at risk.
2. Sole proprietorship owners may have higher tax rates as everything is considered earned income.
3. Owners may be limited to using funds from their personal savings accounts or consumer loans to fund their business.
4. Well-established employees may be less attracted to sole proprietorships compared to larger organizations. That is, sole proprietorships may have less credibility than other business types.
5. As the only business owner, the demands and pressure lie only on you.
6. The business entity dissolves when the owner passes away or retires.

There are several categories to help distinguish between sole proprietorships and LLCs. These include liability, taxation, and management/ operational style.

Liability

Generally, sole proprietors own small or part-time businesses with no employees. It costs nothing to establish a sole proprietorship. Unlike a sole proprietorship, an LLC is a hybrid of the partnership and corporate forms that allows the liability protection of a corporation with the tax advantages of a partnership. As hinted above, this is a crucial difference between the two business structures. Sole proprietors are not protected from personal liability.

Taxation

Another essential difference between LLCs and sole proprietorships is tax flexibility. Only LLC members can choose how they prefer to have their business taxed. Only LLC members can choose how they prefer to have their business taxed. They can also elect to have corporate tax status. Dividends are taxed at a lower rate than typical business income when the company is taxed as a corporation. Corporation retained earnings are also not subject to income tax. LLC members must pay taxes on all business income, whether retained or not. A corporation has eligibility for additional tax deductions and credits.

Management and Operations

A sole proprietorship is simple in its operations and management structure. The single owner can make any business decision as they see fit. Most sole proprietors can hire employees, experts, and other individuals to help with day-to-day choices with business management. However, the owner only has to ensure that their business operates legally and that the profits cover business expenses.

An LLC's operational and management structure is more intricate. Often it is outlined in an LLC operating agreement. The operating agreement details each member's stake in the business, voting rights, and profit share. The LLC can be collectively managed by all the members or an appointed manager.

If you operate your business as a sole proprietor, you’ll be taxed as a self-employed person, and the income of your business is considered your personal income for tax purposes.

An LLC may make an election to be taxed as a disregarded entity, partnership, corporation, or s-corp. If such an election isn’t made, it’s taxed as either a disregarded entity or a partnership, depending on the number of members it has.

While deciding, strongly consider partnering with Bench's skilled professionals. They'll help organize your finances, maximize deductions, and ensure an efficient filing process for the current year.

Business owners often start with sole proprietorships. It requires minimal paperwork and is simple in design, as shown previously. Once the business grows, transitioning to LLC may have the advantage of offering protection against personal liability for bankruptcy.

Those who want personal liability protection, tax benefits, growth potential, credibility, and consumer trust should strongly consider forming an LLC. It is recommended for businesses with more extensive customer bases, increased risk of liability and/ or loss could potentially benefit from unique tax options and have the possibility for immediate sustainable profit. One immediate downside is the fees and more complex formation process than sole proprietorships. However, this can easily be made up for with the benefits your business can assume by establishing your company as an LLC.

Sole proprietorships work well for small-scale, low-risk, and low-profit businesses. Therefore the risk on an owner’s personal assets is minimal. The best business structure will depend on many factors, and it's recommended that you speak to a business lawyer before deciding.

You can find the forms needed to establish an LLC and any additional information for running a sole proprietorship at the following web address.

https://www2.illinois.gov/dceo/SmallBizAssistance/BeginHere/Pages/StepByStepGuide.aspx