What Is the Difference Between an LLC and a Sole Proprietorship?
The LLC vs sole proprietorship difference comes down to whether the law treats your business as separate from you. A sole proprietorship is you doing business in your own name: you and the business are legally the same person. An LLC is a separate legal entity created under state law, which you own as a member.
That one difference drives almost everything else. The US Small Business Administration (SBA) notes that sole proprietors are personally responsible for their business’s debts, while an LLC generally protects owners’ personal assets.1
For taxes, the two often look the same. The IRS treats a single-member LLC as a “disregarded entity” by default, so its profit is reported on the owner’s personal return, just like a sole proprietor’s.4 Our explainer on what an LLC is covers the company structure in full.
LLC vs Sole Proprietorship at a Glance
The two structures differ most on liability, cost and paperwork.
| Feature | Sole proprietorship | Single-member LLC |
|---|---|---|
| How it starts | Automatically when you start doing business | By filing articles of organization with your state |
| Personal liability | Unlimited: your personal assets are at risk | Usually limited to what you put into the business |
| Default federal tax | Profit on your personal return (Schedule C) | Same as a sole proprietorship, unless it elects otherwise |
| Self-employment tax | Yes, on net earnings | Yes, under default tax treatment |
| Setup cost | Little or nothing, plus any local licenses | State filing fee, which varies by state |
| Ongoing paperwork | Minimal | Annual reports and fees in many states |
| Option to be taxed as a corporation | No | Yes, including S corporation status |
| Separate business bank account | Recommended | Effectively essential |
Most of the LLC vs sole proprietorship decision comes down to the first two rows: how you start, and how much personal risk you are willing to carry.
How Does a Sole Proprietorship Work?
A sole proprietorship is the default structure for anyone who runs a business alone without registering a company. If you sell crafts online, freelance or tutor for pay, you are already a sole proprietor unless you formed something else.
The IRS describes a sole proprietor as someone who owns an unincorporated business by themselves.2 You report business income and expenses on Schedule C with your personal tax return, and pay self-employment tax on your net earnings.
Starting one takes very little. You may need local business licenses or permits. If you trade under a name other than your own, many states and counties ask you to register it as a “doing business as” (DBA) name.
Advantages of a Sole Proprietorship
- Simple and cheap to start, usually with no state filing.
- Easy taxes, with business profit on your personal return.
- Full control of decisions and profits.
- Few formalities, with no annual company reports in most cases.
Disadvantages of a Sole Proprietorship
- Unlimited personal liability for business debts and legal claims.
- Harder to raise money, since there are no shares and lenders rely on your personal credit.
- Less separation between personal and business affairs, which can make bookkeeping messy.
- It ends with you. The business has no separate existence to sell or pass on.
How Does a Single-Member LLC Work?
A single-member LLC is a company you create by filing with your state, owned by you alone. It can hold its own bank account, sign contracts and own property in its own name.
The main benefit is limited liability. If the company cannot pay its bills or loses a lawsuit, creditors generally look to the company’s assets rather than your personal ones.1 That protection is not absolute. Personal guarantees, your own wrongdoing and treating company money as your own can all expose you personally.
Advantages of an LLC
- Personal asset protection in most situations.
- Flexible taxes, including the option to elect S corporation status later.
- More credibility with some clients, suppliers and banks.
- Easier to add owners or sell the business later.
Disadvantages of an LLC
- Formation fees that vary widely by state.
- Annual fees or taxes in many states, sometimes several hundred dollars a year.
- More record-keeping, including strict separation of business and personal money.
- Same default tax bill as a sole proprietorship, so it is not a tax saver on its own.
How Are They Taxed?
Under default rules, the IRS taxes a sole proprietorship and a single-member LLC in almost the same way.
In both cases, business profit flows onto your personal Form 1040, usually through Schedule C. You pay income tax at your personal rates, and self-employment tax on net earnings. Our explainer on how income tax brackets work explains how those personal rates apply.
Self-employment tax covers Social Security and Medicare for people who work for themselves. The IRS sets the combined rate at 15.3%: 12.4% for Social Security up to a yearly earnings limit, and 2.9% for Medicare on all net earnings.3 Half of it can be deducted when working out income tax.
Where the LLC Can Differ
An LLC can choose to be taxed as an S corporation by filing Form 2553. The owner then takes a reasonable salary, which carries payroll taxes, and may receive the remaining profit as distributions without self-employment tax. This can lower the tax bill for profitable businesses, but it adds payroll costs and paperwork.4 A sole proprietorship cannot make this election.
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A sole proprietorship can cost almost nothing to start, while an LLC carries state fees at setup and often every year.
| Cost | Sole proprietorship | LLC |
|---|---|---|
| Formation | None in most places | State filing fee, varying widely by state |
| Business name | Optional DBA filing fee | Included with formation; DBA optional |
| Annual state costs | Usually none | Annual report fee or minimum tax in many states |
| Registered agent | Not needed | Required; you can often serve as your own |
| Licenses and permits | As required locally | As required locally |
| Accounting help | Optional | More often useful, especially with an S corporation election |
Check your own state’s secretary of state website for exact fees. Some states charge under $100 to form an LLC; others charge far more or levy a yearly minimum tax.
Which Should You Choose?
A simple way to settle LLC vs sole proprietorship is to weigh your risk, income and plans against the cost of an LLC.
A Sole Proprietorship Often Makes Sense When
- You are testing an idea or earning a small side income.
- Your work carries little risk of injury, damage or large disputes.
- You have few personal assets to protect for now.
- You want to keep costs and paperwork to a minimum.
An LLC Often Makes Sense When
- You sign contracts with significant liability clauses.
- You work in clients’ homes, handle valuable property or give advice people rely on.
- You have savings, a home or investments worth protecting.
- Your profit is growing, and you may want an S corporation election later.
- You plan to bring in a partner or sell the business one day.
Before you decide, it helps to have a clear plan. Our explainer on business plans shows how to map out your costs, risks and goals.
What About Insurance?
Insurance and business structure solve different problems, so most owners need both.
An LLC limits what creditors can reach, but the company’s own money, equipment and income can still be lost in a claim. Insurance pays for covered losses so the business itself survives. A sole proprietor relies on insurance even more, because there is no company standing between a claim and personal assets.
- General liability insurance covers injuries or property damage caused by your business.
- Professional liability insurance covers claims that your advice or work caused a client loss.
- Commercial property insurance covers equipment, stock and premises.
- Business auto insurance covers vehicles used for work, which personal policies may exclude.
Ask an insurance broker which policies your trade usually needs. Many clients and venues ask for proof of insurance before signing a contract.
How Does the Choice Affect Banking and Credit?
Banks and lenders treat the two structures a little differently, which matters as you grow.
A sole proprietor can open a business bank account, often with just a DBA certificate or Social Security number. An LLC opens an account in the company’s name, usually with its formation papers and an EIN. Keeping all business money in that account is what preserves the LLC’s protection.
For loans, both structures usually rely on the owner’s personal credit at first, and lenders often ask for a personal guarantee. Over time, an LLC with its own accounts and payment history can build business credit separate from yours. Our guide on improving your credit score helps with the personal side.
Can You Switch From a Sole Proprietorship to an LLC?
Yes, and many owners start as sole proprietors and form an LLC once the business is clearly working.
- Form the LLC with your state and name a registered agent.
- Get a new EIN if needed. The IRS generally requires one for an LLC that has employees or elects corporate taxation.
- Open a business bank account in the LLC’s name.
- Move contracts, licenses and accounts into the LLC’s name where possible.
- Update your website, invoices and insurance so clients deal with the company.
Liability protection generally applies from the date the LLC exists, so it does not cover problems that arose before. Insurance remains important in both structures.
A Worked Example
Here is a made-up example of an owner weighing LLC vs sole proprietorship in practice.
Marcus is a freelance photographer earning about $45,000 a year in profit as a sole proprietor. He mostly shoots portraits in his own studio, and his main risk is equipment damage, which insurance covers.
Then he wins a contract to photograph weddings at outside venues. The contracts include liability clauses, and he is now working around guests and expensive property. He also has $60,000 in savings he wants to protect.
Marcus forms an LLC in his state, opens a business bank account and buys general liability insurance. His tax return barely changes, because the LLC is taxed like his sole proprietorship. What changes is that new contracts are signed by the company, and his savings are no longer directly exposed to most business claims.
Common Mistakes to Avoid
A few errors catch out owners of both structures.
- Thinking an LLC lowers taxes on its own. By default, it does not.
- Mixing money in one account, which weakens an LLC’s protection and complicates taxes for both.
- Skipping insurance because you have an LLC. The company’s assets can still be lost.
- Forgetting annual filings, which can lead a state to dissolve an LLC.
- Waiting too long to form an LLC after taking on risky contracts.
- Ignoring estimated taxes. Both structures usually need quarterly payments to avoid penalties.
Good bookkeeping helps in either case. Our explainers on cash flow and revenue cover the numbers every owner should track.
Key Terms Explained
These words come up whenever business structures are compared.
- Sole proprietorship: an unregistered business owned and run by one person, legally the same as the owner.
- LLC: a limited liability company, a state-registered business separate from its owners.
- Disregarded entity: the IRS default status of a one-owner LLC, taxed through the owner’s return.
- Schedule C: the tax form used to report profit or loss from a business run by one person.
- Self-employment tax: Social Security and Medicare tax paid by people who work for themselves.
- DBA: “doing business as,” a registered trade name different from the owner’s legal name.
The Bottom Line
In the LLC vs sole proprietorship choice, a sole proprietorship wins on simplicity and cost, while an LLC wins on protecting your personal assets. Taxes are usually the same under default rules.
Start as a sole proprietor if your risk and income are small, and form an LLC when contracts, risk or savings grow. Whatever you choose, keep business money separate and carry the right insurance. For more, browse our business explainers.
This article is general information, not legal or tax advice. Rules and fees vary by state, so check with your state’s business office or a qualified professional.
Frequently Asked Questions
It depends on your situation. An LLC protects personal assets better, but costs more and needs more paperwork, so it suits businesses with more risk or income.
Not by default, because a one-owner LLC is taxed much like a sole proprietorship. Savings usually come only from an S corporation election, which adds payroll costs.
Usually not with the state. You may need local licenses, and a DBA filing if you use a business name other than your own.
Yes, because the owner and the business are legally the same. Business debts and claims can reach personal savings and property.
Yes, by forming an LLC with your state and moving accounts and contracts into it. Protection generally starts from the date the LLC is formed.
Yes, on net earnings from the business. The combined rate is 15.3%, covering Social Security and Medicare.
Sources
- 1US Small Business Administration (SBA): Choose a Business Structure
- 2Internal Revenue Service (IRS): Sole Proprietorships
- 3Internal Revenue Service (IRS): Self-Employment Tax (Social Security and Medicare Taxes)
- 4Internal Revenue Service (IRS): Limited Liability Company (LLC)
Every figure in this article is checked against the sources above. How we research and fact-check →
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