Founded by a former IRS Agent

Founded by a former IRS Agent

Individual Business Enterprises – LLC or Sole Proprietorship?

April 3, 2015

Individual Business Enterprises – LLC or Sole Proprietorship?

A frequent question people / businesses ask is whether to open a business as a sole proprietorship or as a single-member limited liability company (LLC). There is no single answer for all cases, but small business owners often seem surprised to hear that in some cases there is no reason not to do business as a sole proprietor.

 

What is a Sole Proprietorship?

A sole proprietorship is simply the business owner with no separate entity. Although a sole proprietor would do well to keep separate business and personal accounting records and to segregate business assets and liabilities from the personal, there is no actual legal distinction between them. All owner business and personal assets are subject to owner business and personal liabilities.

The terms “sole proprietorship” and “dba” for “doing business as” are not synonymous or interchangeable. A dba is simply an assumed or fictitious and not a true legal name the business uses. Sole proprietors, partnerships, and corporations may do business under a dba, but it is not a legal form of business entity, only a convention many entities use.

 

Sole Proprietorship Advantages

Sole proprietorships have several advantages over LLCs:

  • Lower startup costs. Sole proprietorships need not register with the state as business entities and pay hundreds of dollars in either filing fees in Illinois and Massachusetts or in high annual minimum taxes in California. Sole proprietors must register assumed names, usually with their counties, pay small filing fees, and publish legal notices of the filings in local newspapers.
  • No annual compliance reports, unlike LLCs, which must file annual reports with and pay annual fees to the state to continue to transact business legally.
  • Easy accounting. Other than records adequate for tax filing purposes, sole proprietorships have no specific accounting requirements. While it is always wise to keep personal and business assets and liabilities separate and distinct, legally sole proprietors can mingle them freely. LLCs must segregate them to preserve their limited liability protection.
  • Easy tax treatment. The Internal Revenue Service ordinarily treats single-member LLCs as disregarded entities with income and expenses reported on the owner tax returns as with sole proprietorships. However, LLCs may elect tax treatment as either regular or S corporations that must file corporate as well as employment tax returns.

 

Sole Proprietorship Disadvantages

Sole proprietorships offer simplicity and lower costs but at some sacrifice for the owner:

  • Personal liability. The owner of a sole proprietorship is personally liable for every obligation of the business, even debts incurred in its name. Creditors have no corporate veil to pierce to reach the owner, whose personal obligation is automatic as a matter of law. LLCs generally limit owner risk of loss to business assets, insulating personal assets from claims on the business. Though not absolute, their limitation of liability is better than none.
  • Limited ability to raise capital. The fact that business assets are subject to claims against the sole proprietor personally may diminish the value of the business or impair its ability to raise capital.
  • Limited transferability of business assets. New LLC owners do not affect the LLC entitlement to all benefits of its contracts, leases, licenses, or permits, many of which may not allow unconsented transfers to other entities. A sole proprietorship that brings in new investors or transfers assets to a buyer ceases to exist. Then the sole proprietor may be restricted from transferring business assets to a newly-formed entity or to a buyer of the business.

 

Which is the better choice? If there is no intent to grow the business with outside capital, no expected need to transfer assets, nor any foreseeable possibility of incurring significant business liabilities, the sole proprietorship advantages may make it the better choice. An LLC deserves strong consideration if the business grows beyond the owner’s efforts, if business risks might threaten personal assets, or if a transfer of business assets may be necessary or desirable.
Whichever the choice, there is no substitute for the knowledge, skills, abilities, and personal touch of Pogosian & Company, CPA in explaining what the numbers say and guiding new businesses as their trusty adviser on the road to financial success.

It’s time to schedule an appointment with Pogosian Nazaryan & Company.