LLC vs Inc or Sole Proprietorship - Which Way Should You Go?
Choosing how to structure your business is a defining moment in the journey of any small business owner, whether you’re just getting started or looking to expand. Because of this, it’s important to know the differences between the business forms available and to make the right decision according to your needs. So, how do you decide between LLC vs inc? Sole proprietorship vs. LLC? What’s the difference between these entities?
The choice of how to form your business sets the standard for how you operate, report earnings, and generally run your business. That’s why every business owner [small business owners] needs to weigh the pros and cons of choosing the right form, whether that’s a sole proprietorship, general partnership, limited liability corporation (LLC), or corporation.
A good starting point for small business owners looking at a new venture is to have a thorough understanding of what they’re trying to build. Knowing where you want to go is a key factor because some business forms are better than others for certain goals.
Before we dive into the available choices, it might help to get a sense of the decision other business owners are making by looking at current numbers.
The most recent US Census findings are astounding. Of nearly 27.7 million firms at last count, 73.1 percent were sole proprietorships, representing 20.3 million firms. Just under 19 percent, or 4.15 million firms, were corporations, and about eight percent were partnerships, which is about 2.2 million firms.
Briefly, if you’re just looking to be your own boss, have no staff, no desire to grow beyond the work you can do on your own, then you’re likely going to want a sole proprietorship. Can’t start your business on your own? Then maybe you need a partnership. Looking to create a business that exists on its own and can continue without you, perhaps a corporation is the right fit. What about LLC vs inc? Or, maybe, you’re looking for something in-between like an LLC with the reduced liability of a corporation but the benefits of a partnership? Whatever you’re considering, make sure you know all the options before making a decision.
What kind of business are you?
When most people imagine a small business owner, they probably picture someone like the local grocer, or cafe, bar, bakery, or shoe store owner—someone, in other words, with a brick and mortar establishment. What many folks fail to realize is that a small business owner is more often than not someone who isn’t tied to a physical storefront. In fact, 52 percent of all small businesses are considered home-based. More surprising is that almost 22.5 million of the 28 million small businesses in the U.S. are considered non-employers, meaning they have no employees whatsoever.
In other words, the majority of small business owners are individuals typically providing goods or services that aren’t tied to a traditional brick and mortar business. And that’s why sole proprietorships make-up almost 75 percent of all business forms. Sole proprietorships are the easiest form and quickest to get started, making them an ideal choice for most small business owners.
To help you determine which might be the best form for your business, we’re going to look at the different types, including sole proprietorships, LLCs, corporations, and partnerships.
What is a sole proprietorship?
Although it’s the most popular business form, a sole proprietorship is actually not a legal entity the way a corporation or LLC is. That’s because a sole proprietorship is just an individual doing business under his or her own or a fictitious name, and all liability for the business falls squarely on the shoulders of that one person.
To operate as a sole proprietorship, one just needs to register the business with the state in which one operates and get all the relevant licenses and permits in order. A sole proprietorship is not a taxable entity in the same way the other business forms are, meaning that when you file taxes for your sole proprietorship, you’ll file the business’s earnings on your personal taxes.
Townsquared member Astrid, who works at Jimmy’s No. 43 (craft beer amazing-ness in NYC’s East Village), who is herself a sole proprietor, offered this perspective:
Most sole proprietors are freelancers, whose liability is very small and whose workforce is non-existent (self-employed). If you get a 1099 (in lieu of a W2), you are technically a business but probably have no need to incorporate. As soon as you assume any liability, you need to form some kind of corporation to protect your personal assets from being part of your business.
The advantage of the sole proprietorship is that it’s quick and easy to set-up. It also offers owners the flexibility to grow into a more complex business form down the road. However, the biggest disadvantage of a sole proprietorship is the liability. You are personally responsible for any debts the business accrues and creditors can hold you liable for debts. Likewise, any lawsuits would be filed against you personally and not a business entity. It’s this liability risk that motivates many small business owners to look at LLCs.
What is an LLC?
Small business owners looking to mitigate risk may feel more comfortable with an LLC. “A single-member LLC is the factual equivalent of a sole proprietorship except that it provides limited liability,” explains Attorney Michael Joseph of the Law Offices of Michael H. Joseph, PLLC. “The corporate structure is understood as a disregarded entity for tax purposes and the income gets filed on a schedule C of your personal tax return.”
As recently as the 1970’s, owners chose from among sole proprietorships, partnerships, and corporations. As business has become more fluid and smaller, companies needed to be more nimble. Some states began to see the benefit of adding another tier to the traditional business forms: thus the LLC was born.
The LLC, or limited liability corporation, is truly a hybrid form of business entity, offering the flexibility and ease of a sole proprietorship and many of the important liability protections of a corporation.
Entrepreneur offers a concise overview of the potential advantages and disadvantage of an LLC:
Advantages of the LLC
- Do not require annual meetings and require few ongoing formalities
- Owners are protected from personal liability for company debts and obligations
- Partnership-style, pass-through taxation, which is favorable to many small businesses
Disadvantages of the LLC
- There is not a reliable body of legal precedent to guide owners and managers, although LLC law is becoming more reliable as time passes.
- Not an appropriate vehicle for businesses seeking to eventually become public or raise money in the capital markets.
- More expensive to set up than partnerships.
- Usually requires annual fees and periodic filings with the state.
- Some states do not allow the organization of LLCs for certain professional vocations.
Sheryl Checkman, of Sheryl Checkman Design, an NYC full-service graphic design consultancy specializing in branding and creative marketing solutions for both the digital and print space, told us why her most recent business is an LLC.
I originally started my business as an S-Corp because back then there wasn’t an LLC option. A few years ago I needed to register a new business, and I did it as an LLC. While it is initially slightly less expensive to open an S-Corp, you end up with an easier tax return with an LLC—just one return rather than one for me personally and one for the company. Also, [with an LLC] you don’t have to pay the various corporation taxes and pay yourself through payroll, taking out taxes and writing a separate check to the bank to deposit your payroll taxes. But you then do have to put money aside for quarterly estimated taxes.
While Checkman prefers to operate her LLC so that she only has one tax return, small businesses can choose to form an LLC and have the LLC treated as a corporation for tax purposes. Ron Zulli, owner of Alpert’s Newspaper Delivery in NYC whose motto is “on time…every time…every day,” put it this way:
The LLC has the benefit of limited liability but can be taxed as a partnership [see below for partnership info]. Therefore, any income that the LLC earns will flow through to the owners on their personal tax returns. [Or] you can elect to be treated as a corporation. In this case, there should only be one level of tax reporting.
Given that LLCs are state as opposed to federal entities, you should be mindful of all the legal quirks unique to your home state if you choose to form an LLC vs inc. For example, software project management consultant Michael Drucker, of MHD Consulting, reminds businesses in NYC that one requirement for LLC formation in New York is posting a notice about the proposed formation for six weeks, “one in a daily paper six times and one in a weekly paper six times.” And, he noted, “That can cost a lot.
“At the end of the six weeks, you get a document indicating you finished the cycle and that [document] has to be sent to the NY Dept. of State with a small fee.”
That’s just one example of the various requirements to keep an eye out for when filing for LLC formation in your state.
But if an LLC sounds appealing, you might now be wondering, why not have all the advantages of incorporating? It’s important to weigh the LLC vs inc question.
LLC vs inc.
Given that the concept of a corporation dates back to antiquity, it’s no surprise that it’s accrued a lot of baggage when it comes to reporting and structure.
This is the behemoth of all business forms and one that might not seem a likely candidate for a small business owner but, with so many startups and tech businesses emerging, the corporation is making a comeback as the go-to choice for new business owners that rely on outside investors.
What is most distinct about a corporation is that it is, in itself, a legal person. This means that, as far as the law is concerned, a corporation is a person who “can bring lawsuits, can buy and sell property, contract, be taxed, and even commit crimes.” However, unlike us mere real people, a corporation is immortal, meaning that it lives on past the life of the owner (or shareholders).
While much more complex in structure that LLCs, sole proprietorships, or even partnerships, a corporation requires a board of directors, shareholders, and rigorous reporting mechanisms in place. If you’re asking the LLC vs inc question, it’s worth knowing that the much higher level of federal oversight required for corporations than for other business forms makes incorporating even more burdensome than simply having a board and shareholders.
However, complex as they are, corporations do offer many benefits as a business form. For example, corporations offer robust protections to both owners and investors in a way that other business forms don’t. The reality, though, is that for a small business, this structure can be a bit daunting at the outset of a venture, especially given its higher annual fees.
Here’s one way of imagining the LLC vs inc question: For example, if you wanted to own a salon, you could form an LLC for Snippity-Do-Da Hair. Business is great, you higher some staff, and then you decide to launch your own product line, which does pretty well. Next thing you know, other salons and stores are asking to carry your product and you need to expand substantially your manufacturing and liability for production costs and deliveries. This is when you might wonder, LLC vs inc? At this stage of the business, incorporation might be a smart move. Keep in mind that you can always incorporate down the road. Again, choosing the right business form is all about finding the right fit for where you are and where you want to be as business—while understanding that it’s hard to predict where your goals will lead you.
What is a partnership?
Sidestepping the question of LLC vs inc, partnerships are formed when two or more persons are co-owners of a business for profit. Whether you sign anything or not, if you co-own a business with one or more people, you’re partners plain and simple, and, unless otherwise stated in a legal partnership agreement, you are each individually responsible for all the business debt and liability. Still, partnerships, like sole proprietorships, are relatively easy to form and can have a low tax burden, making them appealing to many prospective business owners.
The most important thing to do when forming a partnership is to get an attorney to draft your partnership agreement. This document will ensure that you and your partners are protected as much as possible from any issues that might arise.
Final advice for choosing your business form
There are a lot of options out there for you to structure your business, beyond LLC vs inc. And, a lot of your decision is going to depend upon a reconciliation of where you are at now and where you want to be. The best advice we’ve heard when it comes to business formation is from stellar photographer Devon Jarvis, “Talk to a lawyer as well as an accountant.”