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Sole proprietorships and LLCs are the two most common business structures favored by small business owners. But which one is right for you? — Getty Images/filadendron

When you’re starting a new business, it’s important to set up the right business structure. And most small business owners favor setting up either a sole proprietorship or an LLC. But how do you know which to choose?

Sole proprietorship vs. LLC: What’s the difference?

A sole proprietorship is an unincorporated business run by one person. It is one of the most common ways to start a business in the United States, probably because it’s also the simplest type of business to start and run.

If you want to operate as a sole proprietor, there’s no action needed on your part. Assuming you’re the sole owner, you’re automatically classified as a sole proprietor. However, there’s also no legal distinction between you and the business, so you’ll lose out on certain liability protections. And since the business is considered an extension of you, it’s not taxed separately.

In comparison, a limited liability company (LLC) is a legal entity that’s formed at the state level. As an LLC, there’s a separation between you and the business. This separation means you receive liability protection from any debt or lawsuits the business incurs.

To set up an LLC, you’ll have to register your business with your state's Secretary of State. Every state has different criteria for setting up an LLC, so you’ll have to see what the guidelines are in your area.

Sole proprietorship: Pros and cons

A sole proprietorship is the fastest way to start a business. There’s no state paperwork to fill out or fees to pay, which makes it a popular option for freelance contractors. It may be a good choice if you’re looking to test out a service-based business.

As a sole proprietor, you’re the only business owner, and you’re not required to conduct shareholder meetings. And as a sole proprietor, you’ll have a much easier time come tax season since you don’t have to file a separate return for the business. You'll report any income you earn on your personal tax returns.

Operating as a sole proprietor will give you a lot of freedom, but there are drawbacks to consider. For instance, you’re going to be personally responsible for any liabilities the business incurs. And if you’re sued for damages caused by the business, your personal assets will be at risk.

[Read more: Guide to Sole Proprietorships]

If you’re on the fence, it can help to consult with other business owners to learn what path they took when first getting started.

LLC: Pros and cons

When you set up an LLC, you’re creating a separate business entity. For that reason, you may be seen as more credible by your clients and business peers. And if you ever need to take out a small business loan, it’s easier to do this as an established LLC.

Many people choose to set up an LLC because of the liability protections that come with it. As an LLC, you’re protected against lawsuits, debt and other business obligations. You’ll just need to make sure to set up your LLC correctly and avoid mixing business and personal assets.

However, one of the downsides of setting up an LLC is all the paperwork that comes with it. You’ll have to complete any forms required by your state and pay the additional fees that come with it. And most states require that you file annually.

In addition, depending on where you live, you may have a bigger tax burden as an LLC. You’ll have to pay federal, state and local taxes regardless of where you live, but some states also require that you pay state business taxes and unemployment taxes.

[Read more: What is a Limited Liability Company?]

Which business structure is right for you?

Choosing a business structure is an important decision every entrepreneur needs to make. And the right choice for you will depend on your goals and the type of business you run.

If you’re looking to hit the ground running, operating as a sole proprietor is the quickest way to get started. There’s no paperwork for you to fill out, and you can focus solely on finding clients and generating revenue. However, you will lose out on the liability protections that LLC members enjoy.

If you’re on the fence, it can help to consult with other business owners to learn what path they took when first getting started. And it can be beneficial to seek out the guidance of an attorney or CPA that has experience working with small businesses.

[Read more: When一And Why一to Consider Changing Your Business Entity]

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published March 05, 2021