By Joshua Bam
This is a common question many sole owner start-ups face as they find their market footing and plan their long term goals. The answer is full of potentially unknown considerations that we’ll clarify and explain here so you can decide if changing from a sole proprietorship to a limited liability company is the right option for your business.
A sole proprietorship is an unincorporated business with a single owner. You’re considered a sole proprietorship if you haven’t formed a business entity by filing paperwork with a state and are simply running a business in your own name or a trade name.
Basically, if you’re selling services or goods on your own and haven’t formalized your business with a state, you’re considered a sole proprietorship by the IRS and the state(s) in which you do business. For example, a high school student who mows lawns and collects payments is a sole proprietor unless they register as a different entity with the state. In short, a sole proprietorship is you and you are your business.
The benefits of sole proprietorships include less paperwork, less cost to form and maintain, and easy to operate. The downside of running a sole proprietorship is that any losses or claims against your business are claims against you personally and may result in loss of your home, savings, or other personal assets. In short, if someone sues your business, they’re suing you personally.
Limited Liability Companies (LLCs)
Because of personal liability, many people choose to form a limited liability company, or LLC. If you are the owner of an LLC and it is sued, only the business is being sued separately and apart from you personally. If the LLC is liable, only the LLC assets are at risk, not your personal assets, so long as you’ve followed the rules of limited liability protection by making sure your personal and business assets are always kept entirely separate.
Other than mitigating personal liability, LLCs offer tax flexibility. LLCs can choose to be taxed as partnerships, S-corporations, or C-corporations by filling a simple form with the IRS. Sole proprietorships can only be taxed in one single way, which often results in self-employment taxes.
For example, many LLCs choose S-corporation taxation so that they can receive a legal break in self-employment taxes. Sole proprietorships pay self-employment tax on all income earned, which might result in a larger tax bill. S-corporations can also pay dividends and have other flexibilities (but also come with more rules).
We usually recommend LLCs to protect our clients’ personal assets and provide for tax flexibility. In Washington State, we provide the following services for our clients for a flat fee:
- Filing with the Secretary of State
- Obtaining a Federal Employer Information Number
- Business Licensing
- Drafting LLC Agreement and Owner Consent Resolutions
State filing fees for LLCs are usually about $250 to file with the state. In addition, there are various fees for local licensing (usually an additional $50 in Washington for new businesses). LLCs also have to renew their entity annually.
Operating an LLC as a sole owner versus running a sole proprietorship is not that much different other than keeping separate accounts and records and keeping up with paperwork. We help take these stressors off of our clients by providing registered agent services and staying involved with clients each step along the way.
If you’re making less than $12,000 a year, have a low-risk activity, and don’t have any other streams of income or personal assets to protect, a sole proprietorship might still be OK for you.
On the other hand, if you are making a reasonable income, are engaged in activity that could result in legal claims or have other revenue and/or personal assets to protect, forming an LLC is well worth the cost and paperwork. Additionally, an S-corporation election in an LLC could result in tax savings to you which a sole proprietorship cannot provide. It’s important to note that this analysis is general only, and you should speak to your attorney to get specific details for your specific situation.
If you think an LLC is right for you, let us help. Give the attorneys at Gravis Law a call and we can set you up with a consultation to let you know your options.