LLC vs Sole Proprietorship: What's the Difference?

For many entrepreneurs, the legal aspects of starting a business loom large. One of the first things you’ll have to figure out when opening your business, and reconsider as you grow, is your business structure. If you’re comparing a Limited Liability Company (an LLC) vs a sole proprietorship, this can be an important choice. But it’s not as complicated as it might sound.

The differences of legal business structures: LLC vs. sole proprietorship vs. single-member LLC vs. corporation

	LLC	Sole proprietorship	Single member LLC	Corporation
How it works	Owner(s) and business are separate legal entities	Owner and business are the same legal entity	Business is a separate legal entity with one owner	Business is a separate legal entity, multiple shareholders
Benefits	Protects personal assets from business liabilities	Simple, low-cost, easy startup	Personal asset protection, simple setup	Easy scalability and room for growth
Business insurance	Protects business assets from loss, provides liability protection	Protects you personally (no division between personal and business assets)	Protects business assets from loss, provides liability protection	Protects the corporation as its own entity
Taxes	Flexible; default is pass-through taxes, but can elect to be taxed as a corporation	Business income and expenses included in personal tax return	Flexible; default is pass-through taxes, but can elect to be taxed as a corporation	C corp (double taxation) or S corp (pass-through taxation) if it qualifies

What are the benefits of an LLC?

If you run your own business and you don’t take any legal steps to separate your personal assets from your business assets, you’re a sole proprietor. This is the default for any small business owner. Your business assets and your personal assets are intertwined.

If you take steps to register your business as a limited liability company, this separates your personal liability from your business liability. This protection is one of the primary benefits of registering as an LLC.

If a customer sues your business and your business operates as an LLC, they likely recover any judgments from your personal assets, like your personal bank accounts, home or car. Your liability, or what you could lose, would be limited to your business assets.

LLCs also offer additional benefits that are missing when you operate your business as a sole proprietorship:

Tax flexibility: You can choose the same tax treatment as a sole prop, or be taxed as an S corp.
Multiple owners: You can add more owners to your business beyond yourself.
Simpler accounting: Operating as an LLC can help you cleanly divide your business accounting from your personal ones, such as investments, property ownership, etc.

The drawback to registering your business as an LLC vs. a sole proprietorship is that you must file formal documentation with the state, including submitting articles of organization, an operating agreement for your business and a business license. You’ll also need to register for an Employer Identification Number (EIN) with the IRS and submit annual paperwork and fees.

Business insurance for LLCs

Registering as an LLC protects you personally, but it doesn’t protect your business from liability. For that you’ll need business insurance for LLCs to limit your business’ financial losses from the cost of legal defense, property damage, medical bills or other costs that could wipe out a business after a single lawsuit. Without business insurance, your LLC’s cash, as well as its business assets like real estate, equipment and vehicles, could be at risk.

Some common types of business insurance you may want as an LLC include general liability insurance to help protect your business from the cost of non-employees who get hurt at your business or damage you cause to other people’s property, commercial property insurance to help protect your own business property like products, inventory, furniture, fixtures and the building itself, and workers’ compensation insurance, a requirement in most states if you have employees.

Taxes for LLCs

LLCs offer tax flexibility. When you register as an LLC, you can keep it simple and add your business income to your personal taxes. It works the same as taxes for a sole proprietorship: you pay personal taxes on the income as well as the self-employment taxes. This is called pass-through taxation because the profits “pass through” to your personal returns, and you pay your individual tax rate based on them. The LLC itself doesn’t pay federal taxes.

LLCs can elect to be taxed as an S corp without becoming a corporation legally. Your income would be paid to you as salary and subject to payroll taxes.

A tax professional can help you determine which method is best for you and your business.

LLC vs sole proprietorship

If you run your business as a sole proprietorship, there would be no division between your business and personal assets. A dissatisfied customer could sue you for all that you have personally as well as the assets of your business.

The difference between a sole proprietorship and an LLC comes down to simplicity and protection.

Sole proprietors need no official paperwork to open and run their business. This is the default corporate status.
LLCs need to file with the state.

There’s no formal cost associated with running your business as a sole proprietorship, while organizing as an LLC will require you to pay filing fees, license fees, reporting fees and other costs.

Sole proprietorship leaves you personally liable for costs if you’re sued, while an LLC creates a clear distinction between your personal and business assets.

What’s the definition of a sole proprietorship?

A sole proprietorship is an unincorporated business owned and operated by a single person. If you aren’t registering your business with the state but do have income and expenses that are separate from your regular household expenses, then you have a sole proprietorship. This includes people who make things, teach classes, sell products, provide creative services or consult.

For example, suppose you’re a freelance designer. You run the business under your own name and you deal directly with clients. If there’s no official LLC formation filed with the state, you’re a sole proprietor, the only owner of your business.

Sole proprietorships are the simplest business structure, as you and the business are the same legal entity. There’s no formal registration required, and you report your business income on your personal tax return. Being a sole proprietor is the default business structure for anyone doing business alone without forming an entity.

Business insurance for sole proprietors

Sole proprietor business insurance can help cover some costs from legal action, as well as some costs associated with property damage or medical bills.

General liability insurance is one of the most common coverage for sole proprietors to help protect your business from the cost of non-employees who get hurt at your business or damage you cause to other people’s property.

If you run your own business inside your home or rent a commercial office, warehouse, or storefront, commercial property insurance could help protect your own business property inside such as laptops or other equipment, products, inventory, furniture, fixtures and the building itself.

If you have employees, workers’ compensation insurance is a requirement in most states.

If your business sells advice, knowledge or professional services, such as a consultant, an accountant, an insurance agent or a real estate agent, you may also need professional liability insurance (also called errors and omissions insurance, or E&O) to help protect you from the legal defense costs of professional mistakes that cost a client money — even if you’re found not to be at fault.

Taxes for sole proprietors

If you run a business as a sole proprietor, you include your business income and expenses on your personal taxes. You’ll be taxed on your profits, not gross revenue, based on your tax bracket. You’ll owe self-employment taxes as well (the portion normally covered by an employer — Social Security and Medicare). You’ll also be able to deduct your business expenses, such as a home office, computer equipment and software, advertising costs and more.

As with an LLC, with pass-through taxation you don’t have to file a separate business income tax return when you’re a sole proprietor.

Sole proprietorship vs single-member LLC

A sole proprietorship is not the same as a single-member LLC. As a sole proprietor, you and the business are one and the same. When you register as a single-member LLC, you create a legal entity.

What does it mean to be a single-member LLC?

A single-member LLC is simply an LLC with one owner. A single-member LLC is not the same as a sole proprietorship legally, although it can be taxed like one.

Once you form the LLC, legally, you and the business are separate entities, and your personal assets are protected from legal action against your business (in most cases).

Business insurance for single-member LLCs

Business insurance can help protect your LLC and its assets, but your personal assets are shielded by the LLC’s structure.

Just like an LLC, single-member LLCs should consider business insurance for the risks they face. General liability insurance is one of the most common types of insurance coverage for a business because it can cover a broad range of risks, including when someone gets hurt on business property or when you accidentally injure someone else’s property.

Business commercial property insurance should be considered if you want protection for your own business property at your business site. This could help out if your business falls victim to theft, fire, vandalism and some severe weather incidents. It can help cover property at your business location like laptops and equipment, machinery, furniture, any products you sell or inventory in your stock room.

General liability and commercial property coverage can be combined together – often at a better price than two separate policies – into a Business Owner’s Policy (BOP insurance).

Taxes for single-member LLCs

The IRS treats single-member LLCs as “disregarded entities,” meaning it will ignore the business as separate from the owner. You file taxes the way a sole proprietor would, including the income and expenses on your personal tax return (using Schedule C) and paying both individual income tax and self-employment taxes. This method of taxation is the default.

However, you can elect a different tax treatment. As a single-member LLC, you could instead choose to file taxes as either an S corporation or a C corporation.

If you choose to file as an S corp, you’d pay yourself a salary from business revenue and pay payroll taxes on it. You could take the remainder of your profits as distributions that aren’t subject to payroll taxes. This is a choice for higher-income single-member LLCs.

What does it mean to be a corporation?

A corporation is a more formal business structure with stricter rules. It’s completely separate from the people who own it, and is treated as its own legal entity. There are two different tax classifications for corporations: C corporations and S corporations.

C corporation

C corps are the default corporate structure. The business pays corporate taxes. And as an owner, you’ll also pay income tax on the distributions you receive. It’s considered “double taxation” for this reason.

C corps are a common structure for startups seeking investors. You can have multiple owners or shareholders, issue shares of company stock and welcome foreign investors. These features make it easier to scale the company, raise outside funds and plow profits back into the business.

S corporation

An S corp is a type of tax treatment for corporations. Filing as an S corp avoids double taxation, as it’s considered a pass-through entity, so there’s no corporate tax. It can also help reduce what you pay in self-employment taxes since you’re on the payroll and you can take owner distributions.

S corps have more limits on the number and type of owners you can have than with a C corp. S corps are capped at 100 shareholders, who must be US citizens or residents. In some cases, a shareholder can be a trust, estate or tax-exempt organization, but it can’t be a corporation or LLC.

Business insurance for corporations

Since a corporation can be sued, own assets, or enter contracts like a person, it has distinct insurance protection needs. The corporate structure provides liability protection for individual owners, but for the company itself requires business insurance for its own liability protection.

In addition to standard business insurance coverages like commercial general liability, commercial property insurance and professional liability insurance/E&O insurance, corporations may also benefit from directors and officers insurance (D&O). This coverage could help protect officers and directors of the company against legal claims regarding management decisions. It can also offer protection in case of regulatory issues or mismanagement.

Taxes for corporations

A corporation is a separate legal entity, and it pays taxes as one, too.

A corporation can file federal taxes as a C corp or an S corp. C corp is the default filing method.

To file as an S corp, your corporation must meet specific requirements, including its number of members, type of members and class of stock.

The benefit of filing as an S corp is avoiding the double taxation of a C corp.

Business structures for independent contractors

An independent contractor is someone hired to perform specific services for someone else, whether it’s a client or a company.

Independent contractors are not employees. They don’t receive benefits like vacation time or health insurance, and they control their time and work hours. They also pay their own taxes. A freelancer is an independent contractor; they offer services for hire without joining the company as an employee.

An independent contractor is self-employed, and they can choose their own business structure, whether that’s sole proprietorship, LLC or S corporation. Independent contractors receive 1099 forms from each client at tax-time, not W-2s as employees do.

How ERGO NEXT can help protect your small business

No matter what type of business structure you choose, ERGO NEXT makes it fast, easy and affordable to protect your small business — and you can do it all online.

We’ll ask a few questions about your business and give you a quote. You can select your coverage options and buy your policy in about 10 minutes. You can share unlimited certificates of insurance at no extra cost, and you can access your policy 24/7 via web or mobile app.

If you have questions, our licensed, U.S.-based insurance professionals are available to help.

Start a free quote with ERGO NEXT.