LLC vs. Sole Proprietorship: Which Should You Choose?

Here is the decision in one sentence: the moment you sell something as an individual, you are already a sole proprietor, which is the free, automatic default; an LLC is something you pay your state to create because it puts a legal wall between your business's debts and your personal assets. Everything else on this page is detail about when that wall is worth paying for.

The good news is that this is rarely a permanent choice. Many businesses start as sole proprietorships and convert to LLCs once they have revenue, contracts or risk worth protecting. The conversion is routine paperwork, not a legal ordeal. So do not let this decision stall your launch. If you are still working through the bigger picture, our guide on how to start a business shows where this fits; it is step 3 of 10.

Side-by-side comparison

Both structures are pass-through for taxes by default, both can hire employees, and both can open a business bank account. The real differences are liability, cost, paperwork and options.

Liability: what an LLC actually protects

Liability is the main reason to form an LLC, so it is worth being precise about what it does and does not cover.

What it generally protects: If the business owes money it cannot pay, such as a supplier bill, a lease or a judgment against the company, creditors can usually only go after the LLC's assets, not your house, personal savings or car. That is the "limited" in limited liability.

What it does not protect:

• Your own negligence. If you personally damage a client's property or injure someone while working, you can usually be sued personally, LLC or not. This is why insurance matters more than structure for most service businesses.
• Personal guarantees. Most small business loans, credit cards and commercial leases ask the owner to sign a personal guarantee. If you sign, you owe it.
• Commingled money. If you run personal expenses through the business account, skip records or treat the LLC as an extension of yourself, a court can disregard the LLC (called "piercing the veil").
• Unpaid payroll taxes. Owners can be held personally responsible for certain unpaid employment taxes.
• Fraud or illegal acts. No structure shields these.

Taxes: self-employment tax and the S-corp question

The most common misunderstanding about LLCs is that they save tax. By default, they do not.

Default treatment is the same

The IRS treats a single-member LLC as a "disregarded entity". You report profit on Schedule C with your personal return, exactly like a sole proprietor. A multi-member LLC is taxed as a partnership by default, filing a partnership return and issuing each member a K-1. In both cases, profit "passes through" to the owners' personal returns.

Self-employment tax

Sole proprietors and LLC owners both pay self-employment tax on net profit, which covers Social Security and Medicare. It is roughly 15.3% on most self-employment earnings, on top of regular income tax, with the Social Security portion stopping above an annual wage cap. Half of it is deductible. This is why the common rule of thumb is to set aside about 25–30% of profit for taxes; your real figure depends on your income, state and deductions.

S-corp election basics

An LLC can ask the IRS to tax it as an S corporation. In simplified terms, you then pay yourself a "reasonable salary" through payroll (with employment taxes) and can take remaining profit as distributions that are not subject to self-employment tax. That can lower the total tax bill, but it comes with real costs:

• Running payroll, with quarterly payroll filings
• A separate business tax return, usually prepared by an accountant
• The obligation to pay yourself a salary that is reasonable for your work
• Possible state-level taxes or fees on S corporations in some states

Because of those costs, many accountants suggest it is not worth considering until profit is consistently in the range of roughly $40,000–$80,000 or more a year, depending on your state and situation. Treat that as a reason to have a conversation with an accountant, not a rule. The election does not require an LLC (a corporation can elect too), but an LLC is the usual starting point for small businesses.

What each option costs

Before you file, look up three numbers on your state's official business filing site: the formation fee, the annual report fee, and any annual minimum tax. Together they tell you the true yearly cost of an LLC in your state. Never pay a third party for an EIN; it is free directly from the IRS.

When a sole proprietorship makes sense

The default structure exists for a reason: most brand-new businesses do not yet have anything an LLC would protect. A sole proprietorship is usually reasonable when:

• You are still testing the idea. If nobody has paid you yet, spending $150–$500 and annual fees on an entity is premature. Validate first; a one-page business plan is a better use of the first week.
• The work is genuinely low-risk. Freelance writing, design, online tutoring, virtual assistance, digital products: the realistic worst case is an unhappy client and a refund.
• It is a small side project. If you are earning a few hundred dollars a month, annual LLC upkeep can exceed the practical benefit, especially in higher-fee states.
• You want zero admin. No state filings, no annual reports, no registered agent.

Even then: open a separate bank account, get insurance if you meet the public, and use written agreements. Those three habits make a later conversion simple.

When an LLC makes sense

An LLC earns its fee when the business could plausibly cost you more than you would willingly pay out of pocket. Common triggers:

• People or property are involved. You work in customers' homes (cleaning, handyman work, pet sitting, mobile detailing), clients visit your space, or you sell products people eat, wear or use.
• You sign meaningful contracts. Leases, supplier agreements or client contracts worth thousands of dollars.
• You are hiring. Employees and contractors add risk you do not want attached to your personal assets.
• You have personal assets worth protecting. A home, significant savings or investments.
• You have a partner. Two people doing business together without an entity are a general partnership by default, each potentially liable for the other's business actions. An LLC with an operating agreement is far safer.
• Clients or platforms expect it. Some corporate clients, landlords, lenders and grant programs prefer or require a registered entity.

When to switch from sole proprietor to LLC

There is no single revenue number, but these signals mean it is time to have the conversation, and usually to file:

• You are about to sign a lease, a large contract or a supplier agreement
• You are hiring your first employee or regular contractor
• You are adding a business partner or investor
• Revenue is steady and growing, roughly $1,000–$2,000 a month or more
• You are moving into higher-risk work: ladders, vehicles, food, children, pets, other people's property
• A client, lender or platform asks for a registered business
• Your accountant suggests looking at an S-corp election

How to form an LLC, step by step

Most single-member LLCs can be formed directly with the state in an afternoon. You do not need a formation service.

1. Choose and check the name. Search your state's business registry, run a free USPTO trademark search, and check the domain. The name usually must include "LLC" or "Limited Liability Company". Our business name ideas guide can help.
2. Pick a registered agent. A person or company with a physical address in the state who accepts legal mail during business hours. You can be your own agent, but your address becomes public record; a service keeps your home address off it.
3. File articles of organization. File online through your secretary of state (or equivalent) and pay the fee. Processing usually takes from same day to two weeks; expedited options cost extra.
4. Write an operating agreement. Required in some states and wise everywhere, even for one owner. It records ownership, how decisions are made and what happens if you leave or die. Free templates exist; get a lawyer for multi-member LLCs.
5. Get an EIN. Apply free at irs.gov; online applications usually issue the number immediately.
6. Handle any publication requirement. Only a few states require it, but check, because missing it can affect your standing.
7. Open a business bank account. Bring the filed articles, EIN and ID. Run every business transaction through it.
8. Register for state taxes and licenses. Sales tax permit if you sell taxable goods, state payroll accounts if you hire, and your city or county business license.
9. Update everything. Insurance policies, contracts, invoices, website, payment processors and marketplace accounts should all show the LLC name.
10. Calendar annual deadlines. Annual report dates and fees. Missing them can lead to penalties or administrative dissolution, which can undo your liability protection.

What about partnerships and corporations?

Sole proprietorships and LLCs cover the vast majority of small businesses, but you will see two other options mentioned.

General partnership. If two or more people run a business together without forming an entity, they are usually a general partnership by default. Each partner can be personally liable for business debts, including debts created by the other partner. It costs nothing to start, which is exactly why people end up in one by accident. If you are going into business with someone, a multi-member LLC with a written operating agreement is almost always a better starting point.

Corporation (C corp). A corporation offers liability protection similar to an LLC but comes with more formalities: a board, bylaws, shareholder records and a separate corporate tax return, with possible double taxation when profits are paid out as dividends. It mainly makes sense for businesses planning to raise outside investment from venture investors or issue stock to many people. For a local service or a solo online business, it is usually more structure than you need.

S corporation. This is a tax election, not a separate type of entity. An LLC or a corporation can elect it, as described in the taxes section above.

Questions to ask an accountant

A one-hour consultation is often enough to settle this decision. Bring last year's numbers or your one-page plan and ask:

• What is the total yearly cost of keeping an LLC in good standing in my state?
• At my expected profit, roughly how much would I set aside for income and self-employment tax?
• Do I need to make quarterly estimated payments, and when are they due?
• At what profit level would an S-corp election be worth modeling for me?
• Which records should I keep so the LLC's liability protection holds up?
• Does my state have any business taxes or local taxes I have not planned for?

Common myths about LLCs

"An LLC lowers my taxes."

Not by default. A single-member LLC is taxed like a sole proprietorship. Any savings come from an optional S-corp election, which has its own costs.

"An LLC means I don't need insurance."

An LLC limits what creditors can take; it never pays a claim. If you damage a client's property, insurance pays. Most service businesses need both.

"I should form my LLC in Delaware, Wyoming or Nevada."

For a small business operating in one state, usually not. You would typically still need to register as a foreign LLC in your home state, pay fees in both, and maintain a registered agent in both. Form it where you actually operate.

"I can't deduct expenses without an LLC."

False. Sole proprietors deduct legitimate business expenses on Schedule C just like LLC owners.

"Once I have an LLC, my personal assets are untouchable."

Protection depends on keeping finances separate, keeping the LLC in good standing and not personally guaranteeing debts. It does not cover your own negligence.

"I need a lawyer or a paid service to form one."

Most single-owner LLCs can be filed directly with the state for the state fee alone. Paid services add convenience, not legal necessity.

The decision rule

If you are still unsure, start legally as a sole proprietor with insurance and a separate bank account, get your first customers, and revisit the question at a clear trigger: your first contract, your first hire or your first $2,000 month. Then use our small business tools guide to set up bookkeeping and invoicing that works for either structure.