Most small business owners in the United States operate as a single owner, the default business entity. While this may work for some businesses for some time, it does not create any legal separation between your business and your personal assets. You will face both the risk of lawsuits and the potential for business indebtedness that you cannot pay. Operating as a sole proprietor is a risk that grows with your business.
If you want to protect yourself and your business, forming an LLC is an affordable option that offers many benefits.
What is a limited liability company?
If you form an LLC, you will create a separate entity that offers liability protection to owners. Your personal assets, such as your home and savings, will not be at risk if your business is sued or you have debts that you cannot pay, as long as you maintain the LLC and comply with the legal requirements. A limited liability company offers flexible management options and functions as a transfer entity by default. This means that forming an LLC from a sole proprietorship will not change your taxes at all, if you have a member.
Choosing an LLC can also offer you additional benefits. It will be easier for you to raise capital through investors and you can deduct your health insurance premiums. The self-employment tax is based on net income and you can pay taxes as a partnership or corporation, if you wish.
Because forming a limited liability company is very affordable and offers many important protections, it is the most popular option for small business owners.
What is a sole proprietorship?
Sole proprietorships have one owner and are not legal entities. This means that operating a sole proprietorship does not provide any distinction under the law between your business assets and liabilities and your personal assets and liabilities. If there are business debts or a lawsuit that you cannot pay through business assets, your home, savings, and other assets will be at risk.
There are benefits to remaining a sole proprietorship, depending on your situation. Taxes are straightforward, you don’t need to register with the state or submit annual documentation, and payroll can be much easier to set up. There will also be no compliance issues to worry about.
Which one is right for you?
The choice between a sole proprietorship and an LLC depends on your business. If you have a very low-risk business that doesn’t involve working in other people’s homes, offering advice, or selling products, staying as a sole proprietor may be your best option. This is especially true if you are very unlikely to incur heavy liabilities. However, if you are concerned about keeping your personal and business assets and finances separate, or if you plan to expand or take on debt, it is worth considering forming a limited liability company in your state or another state.