Washington LLC vs. Sole Proprietorship

Forming an LLC in Washington in Washington offers numerous benefits such as asset protection and tax flexibility. However, understanding the fees, requirements,operating agreement and additional options for privacy using an anonymous LLC is essential. A single member LLC shields owners from personal liability, a stark contrast to a sole proprietorship, where personal assets are at risk. On the other hand, a sole proprietorship offers simplicity but lacks liability protection and tax benefits. Before deciding between the two, consider factors like annual report obligations and tax implications to make an informed choice for your business venture.

A limited liability company (LLC) is a business structure in the United States whereby the owners are not personally liable for the company's debts or liabilities. It is a relatively new type of hybrid business structure that is available in most states, including Washington.

LLCs offer several advantages, including, but not limited to, tax savings, liability protection, privacy (if formed anonymously), increased credibility, and more tax flexibility. One potential drawback is the added complexity when compared to a sole proprietorship. A list of the pros and cons of LLCs is shown below.

PROs:

1. LLCs have incredible flexibility when it comes to organizational and managerial decisions. LLC members can structure the company in almost any way they deem helpful.
2. LLCs can also be managed by company members or by an appointed manager.
3. In addition, LLCs have the ability to decide how they will be taxed. One option for taxation includes pass-through taxation. This taxation option is where individual members report LLC profits on their own income tax returns. More information on taxation options is available below.
4. LLCs do not have to follow the same stringent corporate regulations required when operating corporations.
5. There are no limitations on how many members or who may be a member of an LLC.

CONs:

1. There are more tax options available for LLC companies. This can cause increased complexity and difficulty in navigating the best options.
2. Across state lines, tax and liability treatment is not the same.
3. There are some limitations on transferring LLC ownership.
4. LLCs are required to use accrual-based accounting methods. This method records revenues and expenses before payments are received or issued.

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, there is no legal distinction made between the owner and the business. There are no necessary steps or paperwork you need to submit when operating a sole proprietorship. However, 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.”

There are several advantages to sole proprietorships, including mainly the convenience and simplicity of the business structure. Although sole proprietorships offer freedom and flexibility initially, they can also come with financial risks later down the road for the owner. Below is a detailed list of the pros and cons of running a sole proprietorship.

PROs:

1. The most straightforward and least costly form of business structure
2. Maintenance costs are minimal
3. Sole proprietorship owners have freedom and control over their business decisions within the limitations set by law.
4. Business profits go directly to the owner. Taxation is, therefore, simpler, and the owner can simply file their personal tax return and not worry about taxation at the business level.
5. It is relatively easy to convert a sole proprietorship to a different business structure. This can be particularly advantageous once the business grows and the owner desires protection from personal liability for the business’s debts or obligations.

CONs

1. Sole proprietorship owners have direct liability for all the debts against the business. The business and personal assets of the owner may be at risk.
2. There is also potential for higher tax rates for this business entity as everything is considered earned income.
3. Owners are at a disadvantage when it comes to raising funds. They may often be limited to using funds from their personal savings account or consumer loans.
4. It may be challenging to attract well-established employees with experience compared to larger organizations or those who desire the opportunity to become an official business member.
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 important 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. It is the single owner that 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 in 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.

When considering either option, we highly recommend collaborating with Bench's proficient professionals. As your dependable partner, Bench stands prepared to help you organize financial records, optimize deductions, and ensure a seamless and 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 an 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 that 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.