Getting ready to start an ecommerce business? Your store launch checklist is likely packed with fun things like finalizing your logo and branding, sourcing the perfect products, and building out your marketing plan. And while starting your own business is certainly exciting, it often requires some not-so-exciting decisions, like choosing a business structure.
One of those decisions could be whether to launch as a sole proprietorship or an LLC. This decision can have a major impact on your compliance obligations, how you pay taxes, and your personal liability.
This guide compares differences between sole proprietorships and LLCs to help you decide which business type is right for you as a new business owner.
What is a sole proprietorship?
A sole proprietorship is the most basic type of business. It is an unincorporated business owned by a single individual, with no legal separation between entity and owner. If you own a sole proprietorship, you solely control the business and its income. Your business profits pass through to your personal tax returns and are taxed at the individual rate.
Creating and operating a sole proprietorship is a relatively simple process, making it a popular choice among the self-employed (like freelancers), small business startups, and low-risk businesses like print-on-demand companies. Unless you’ve taken any steps to legally establish your business, it’s a sole proprietorship by default. There’s no formal registration or filing process required to start this type of business.
Read our in-depth guide to the advantages and disadvantages of operating a sole proprietorship to learn more.
Pro tip: Laws for sole proprietors vary by state and nature of business. It’s always best to check with your local jurisdictions to find out what the requirements are for setting up your sole proprietorship, as well as noting any necessary tax filings, licenses, or permits.
What is an LLC?
An LLC, or limited liability company, is a type of business structure that is either owned by a single person or entity, or owned jointly by multiple partners, called members. LLCs offer liability protections for their owners, similar to corporations, but taxation is similar to sole proprietorships.
As an LLC, your business’s profits pass through to each member, and taxes are paid at personal tax rates. There is legal separation between the business entity and owner. This protects owners (you and your partners) from personal liability for the business’s debts and legal claims, although the extent of protections may vary by state. An LLC also can establish its own business credit. LLCs are popular with consultants and ecommerce businesses, for example, due to their flexibility and liability protection.
LLCs are formed in the state in which they operate, and typically require you to get a federal employer identification number (EIN) and complete paperwork such as certificates of formation or articles of organization. Documentation requirements can vary by state.
Learn more about the advantages of forming an LLC.
LLC vs. sole proprietorship: what’s the difference?
LLCs and sole proprietorships can appear similar in many ways. A single-member LLC resembles a sole proprietorship because it also has one owner and is generally taxed the same. Despite similarities, there are key differences between the two business structures. Here’s a closer look at how they differ. But before you make any decisions that can affect your business, always consult a tax professional.
The most well-known difference involves liability. Overall, a limited liability company offers more personal liability protection. When you form a single-member LLC, you shield your personal assets such as your house, car, and personal bank accounts from liability claims against the company. If the LLC has debts, the owner also doesn’t risk any personal liability to pay off those debts if the business can’t do so on its own. That’s because the business remains a legally separate entity from the owner.
Sole proprietorships, by comparison, don’t shield you from debts and legal claims. You are not considered a separate legal entity. For example, if you face business debts as a sole proprietor, you have no protection from a lawsuit and your personal assets are exposed to liability.
Learn more: How To Get a Business License
A single-member LLC offers more tax flexibility than a sole proprietorship. You can choose to be taxed as a sole proprietorship or elect to be treated as an S corporation (S corp) or C corporation (C corp) for income tax purposes. While S corporations could offer some of the pass-through tax benefits enjoyed by LLCs and sole proprietorships, S corps have very specific requirements for eligibility and tax filings. Business owners should consult with a licensed tax adviser to determine the best structure.
As a sole proprietorship, you own a business that has pass-through taxation, meaning business income flows through your business and is reported on your personal tax returns. Sole proprietors are required to pay self-employment taxes, which are estimated and paid quarterly. The self-employment tax rate is 15.3% and is a combination of Social Security and Medicare taxes.
It’s a good idea to consult a tax professional when managing your taxes and making financial decisions as an independent contractor.
There are more costs associated with starting an LLC. Most states require LLCs to create a separate entity name (also known as doing business as, or DBA) and register with the Secretary of State. According to the US Small Business Administration, registration usually costs less than $300 but can vary by location and type of business. You may also be required to get licenses or permits, depending on industry and state. As an LLC, you may have to pay ongoing fees for annual report filings and permit and license renewals.
A sole proprietorship can be more affordable to establish, as it’s typically free to start and there’s no formal process or paperwork involved. While not required, some sole proprietorships may choose to register a DBA trade name. DBA registration costs depend on location. Like LLCs, sole proprietorship business owners need to check local business operation regulations for any necessary licenses or permits and related costs.
Learn more: How To Register a Business: What You Need to Do
The funding process is usually easier for LLCs. They can raise capital through crowdfunding, business loans, and other financing options. Compared to sole proprietorships, LLCs are generally viewed as safer investments due to their separate business entity status, which protects investors’ personal assets. A single-member LLC also has the option of bringing on additional partners to invest in the business.
Sole proprietorships typically have more limited financing options. Many banks will only issue sole proprietors personal loans, which may be more restrictive about business use compared to business loans.
Management and control
A sole proprietorship can only be owned and operated by one individual. While LLCs have flexibility when it comes to management and control. Single-member LLCs can operate the same way as sole proprietorships, with one owner overseeing business operations. However, you have the option to bring on additional members. In such cases, business owners have shared control and ownership.
With sole proprietorships, the responsibility of business operations and management rests with an individual owner who has complete control. If you own a sole proprietorship, you also incur more responsibility—and it can be challenging to take on all roles and implement a growth strategy.
Learn more: How To Start An LLC: Everything You Need to Know
See our state-specific LLC guides:
- How to start an LLC in Alabama
- How to start an LLC in Arizona
- How to start an LLC in Arkansas
- How to start an LLC in California
- How to start an LLC in Colorado
- How to start an LLC in Connecticut
- How to start an LLC in Delaware
- How to start an LLC in Florida
- How to start an LLC in Georgia
- How to start an LLC in Hawaii
- How to start an LLC in Idaho
- How to start an LLC in Illinois
- How to start an LLC in Indiana
- How to start an LLC in Iowa
- How to start an LLC in Kansas
- How to start an LLC in Kentucky
- How to start an LLC in Louisiana
- How to start an LLC in Maryland
- How to start an LLC in Massachusetts
- How to start an LLC in Michigan
- How to start an LLC in Minnesota
- How to start an LLC in Mississippi
- How to start an LLC in Missouri
- How to start an LLC in Montana
- How to start an LLC in Nebraska
- How to start an LLC in Nevada
- How to start an LLC in New Jersey
- How to start an LLC in New Mexico
- How to start an LLC in New York
- How to start an LLC in North Carolina
- How to start an LLC in North Dakota
- How to start an LLC in Ohio
- How to start an LLC in Oklahoma
- How to start an LLC in Oregon
- How to start an LLC in Pennsylvania
- How to start an LLC in Rhode Island
- How to start an LLC in South Carolina
- How to start an LLC in South Dakota
- How to start an LLC in Tennessee
- How to start an LLC in Texas
- How to start an LLC in Utah
- How to start an LLC in Virginia
- How to start an LLC in Washington
- How to start an LLC in West Virginia
- How to start an LLC in Wisconsin
- How to start an LLC in Wyoming
Move forward with your new business
Incorporating a business makes it official in the eyes of the government. You protect your personal assets, build credit for your company, and, in some cases, even enjoy lower taxes. This can make an LLC more appealing than a sole proprietorship, especially as your company grows.
Whether you choose to form an LLC or a sole proprietorship, transforming your idea into a real, official business is ultimately up to you.
DISCLAIMER: These guides are for informational purposes only and do not constitute professional legal or tax advice. Please consult independent legal advice and your own tax advisers for information specific to your country and circumstances. Shopify is not liable to you in any way for your use or reliance on these guides.
- This Founder is Selling Spirituality and Everyone’s Buying
- The 13 Best Dropshipping Suppliers in 2024
- How to Start a Dropshipping Business: A Complete Playbook for 2024
- 17 Ways to Get More Followers on Instagram (2024)
- A Guide to the Sole Proprietor Business Structure
- How To Write a Return Policy (+ Free Template) (2024)
- What Is an S Corp? How to Form and Operate an S Corp
- Now You Can Print USPS Shipping Labels in Shopify, Saving You Time and Money
- Equity Crowdfunding: Is It Right For You?
- What is a Lifestyle Business and How to Start One
Sole proprietorship vs. LLC FAQ
What is the biggest difference between a sole proprietorship and LLC?
- Taxes. A single-member LLC can be taxed differently when certain business entity elections are made.
- Liability. LLCs grant more protections in terms of personal liability.
- Costs. Sole proprietorships are free to start, while LLCs require registration and ongoing fees.
- Funding. It’s generally easier to get external financing for an LLC than for a sole proprietorship.
- Management and control. Sole proprietorships offer more control than LLCs.
What are the downsides of an LLC?
- Dealing with government bureaucracy. LLCs are managed by federal, state, and local jurisdictions, so depending on the nature of your business, you may have to deal with licensing, permits, and administrative tasks.
- Cost. LLCs have more associated costs than sole proprietorships.
What are the downsides of a sole proprietorship?
- Personal liability. The owner of a sole proprietorship is responsible for all debts and losses incurred by the business.
- Difficulty raising capital. Investors are less likely to support sole proprietorships because they are viewed as less formal business entities.