Finding the right business structure depends on several personal and professional factors.
New entrepreneurs or business owners often struggle with whether to form an LLC or sole proprietorship. Regardless of the entity you choose, it has an impact on your legal protection, taxes, and more.
A sole proprietorship is attractive because of the simplicity and low cost. An LLC is appealing because of the personal liability protection, flexibility, and more.
Whether you’re a new entrepreneur or an already established sole proprietorship, it’s important to understand if, and when, you should move into another business structure.
What is an LLC?
An LLC, also known as a limited liability company, is a hybrid business structure that combines the liability protection of a corporation and tax advantages of a sole proprietorship.
Most business owners choose to form LLCs because of benefits like limited personal liability, tax advantages, flexibility, and privacy protection.
Unlike a corporation, an LLC offers a more flexible tax and management structure. And unlike a sole proprietorship, it allows more than one owner, also called members. LLCs also require a little more paperwork, along with startup fees.
What is a Sole Proprietorship?
A sole proprietorship is the simplest business entity to form. It’s defined as an unincorporated business that is owned and operated by one person. This one individual keeps all profits from the business but is also responsible for all liabilities and debts.
If you’re a financial planner or freelance worker, you may already be operating as a sole proprietorship without even knowing it. As a sole proprietorship, there is little to no paperwork or fees. And while there are some businesses that may require permits or licenses, a sole proprietorship means you have complete control over your business and business-related decisions.
Unfortunately, this freedom also comes with a few disadvantages. For example, you have no personal liability protection if someone were to sue your business or if you run into financial issues. Additionally, if your business requires employees, you’re responsible for them and their actions.
LLC vs Sole Proprietorship: What’s the Difference?
Sole proprietors are typically a one-person show. It’s a small, freelance or part-time business with only one owner. While it’s cost-effective, there is no personal liability protection, and if not operated correctly, taxes can become a problem. Because of the hybrid nature, LLC’s offer liability protection, as well as tax advantages.
Aside from legal and liability protection and taxes, there are a few other key differences between an LLC and sole proprietorship. One difference is the formation. An LLC requires owners to file articles of organization with the state, register a business name and registered agent, and obtain business permits. The formation for a sole proprietorship generally means establishing a name and obtaining any business permits if necessary.
In terms of operations and management, LLC owners have equal rights and can share the responsibility of making business decisions. As a sole proprietor, one owner is the key decision-maker for everything.
Finally, paperwork and compliance are also different for both business structures. An LLC must pay taxes, renew licenses, and keep up to date paperwork. A sole proprietorship must pay taxes and renew any licenses they must have to operate.
How are LLCs and Sole Proprietorships
Taxed in Arizona?
When it comes to taxes, how you structure your business makes a big difference. A big difference between LLCs and sole proprietorships is tax flexibility for owners.
For LLCs, pass-through taxation is default, but owners can elect for a different tax status. As a sole proprietor, you will have pass-through taxation.
Pass-through taxation means the owner is taxed as a self-employed person. The income you generate from your business is considered your personal income for taxes. LLCs have the option to be taxed as a sole proprietorship or corporation. This flexibility allows for LLCs to potentially save money and deduct more on their taxes and obtain more credits.
Should You Start an LLC or
Sole Proprietorship in Arizona?
As a new entrepreneur, start-up business, consultant, or freelancer, you’ll more than likely start your business as a sole proprietorship. This business structure allows you to test-run your business and get it off the ground. The fees and paperwork are minimal, so there are generally no up-front costs if things don’t work out.
As your business starts growing and attracting more attention, it’s best to move to an LLC business structure. This will ensure liability protection, tax flexibility, and allow for you to hire more employees or add more owners to help with decision making.
Each business entity comes with its own set of risks and advantages. It’s best to work with an attorney to help you determine which structure will help you meet your professional goals.