It is essential to know the difference between sole proprietorship vs LLC for online business when starting a new online business.
That is mainly because a limited liability company and sole proprietorship have different tax treatments and legal requirements.
You must understand the differences between both these entities so that you’re making the right choice for your new venture.
Let’s break it down and start talking about both of these entities separately first.
Sole Proprietorship vs LLC for Online Business
Before we exactly tell you which one is better than the other, let’s discuss each of these individually along with each of their advantages and disadvantages.
What Is a Sole Proprietorship?
A sole proprietorship is an unincorporated business that has only one owner.
This is the least expensive and simplest type of business to establish.
An individual who chooses to operate the online business by themselves becomes a sole proprietor by default.
For instance, if you are operating as a freelancer, retailer, running an online business, or selling goods and services, you automatically become the sole proprietor.
That is unless you have opted for a different business structure.
It is quite simple to identify a sole proprietorship online business.
That’s because the business’ name will be the same as the owner’s name.
That said, sole proprietorships can also operate under a trade name or brand name.
One of the main characteristics of this is that there isn’t any legal separation between the owner and his or her business.
That means they are personally responsible for their business’ debts.
Advantages of a Sole Proprietorship
If you choose to form a sole proprietorship, you will get the following benefits:
- Less or No Paperwork
You won’t need state paperwork unless there is a specific license you are looking for such as a business license and/or occupational license.
We recommend that your business files a fictitious name or “DBA” with the state.
- Usually, No State Filling Required
You don’t require to complete annual state filings unless there is a specific industry filing that’s needed by your industry.
- Easier Tax Filing
All the profits and losses go through the business owner’s personal tax return.
You can report them on a Schedule C tax form that you can file along with your personal tax return.
- Tax Benefits
There’s a possibility of enjoying the tax benefits of being self-employed.
This can be a deduction of certain business expenses like business use of your car and home, utilization of self-employed retirement plans such as SEP IRAs (Simplified Employee Pension Individual Retirement Accounts).
It can also be being able to write off regular business expenses like travel and marketing.
Disadvantages of a Sole Proprietorship
With a sole proprietorship, you will have the following drawbacks:
- No Liability Protection
You will have no liability protection against lawsuits, commercial debts, and other obligations.
By this we mean someone can sue you personally for your commercial activities which in turn puts all your personal assets at risk.
- Difficult Equity Financing Acquisition
Outside of your family and friends, it is almost impossible to secure any equity financing for a sole proprietorship.
That is because a lot of investors find investing in a sole proprietorship business very risky.
This ultimately means that your funds will be limited, prohibiting the growth and development of your business.
- Difficult To Establish Credit Line
Establishing a business credit line for obtaining debt financing is difficult for a sole proprietorship.
That’s because a lot of financial institutions tend to categorize this request as a personal loan instead of a business loan.
- Low Market Credibility
There is also lower market credibility when you aren’t operating under a trade name.
This can be resolved easily by making a DBA name (Doing Business As) with the secretary of state or the state’s department of revenue.
However, this comes with additional and ongoing fees.
What Is an LLC?
An LLC, or limited liability company, is a legally separate business entity that is made under state law.
This is a combination of different elements of sole proprietorship, corporation, and partnership and offers a ton of flexibility for business owners.
A company registered as an LLC can decide its operational processes, tax treatment, and management structure.
A single business owner can form a single-member LLC.
If there are multiple owners, then they can form a multi-member LLC.
You will know a business is registered as an LLC because the legal name of the business will end with “limited liability company” or simply “LLC”.
One of the defining features of LLC is that it offers the owner or the owner’s liability protection from obligations and debts of their business.
In the normal course of business, a business creditor or anyone who wants to sue the business cannot come after the company owner’s personal assets.
Advantages of Forming an LLC
If you are opting to make an LLC, you’re essentially making a business entity completely separate from yourself.
In simpler words, you aren’t your LLC, and neither is your LLC is you.
If you are opting for this, you will avail of the following benefits:
- Credibility and Liability Protection
Your market credibility will be at a higher level.
You will also get liability protection against lawsuits, commercial debts, and other obligations.
That is as long as you have set and maintained your LLC correctly and haven’t mingled your personal and commercial assets.
If you avoided personal guarantees, your liability protection will also remain in place.
No creditor can go after all your personal assets in case there’s a lawsuit against your business.
- Easy Debt Financing and Equity
It is significantly easier to get debt financing and equity if you’ve got a separate business entity and a well-established credit score for your business.
Instead of a personal loan, you can pick from small business loans which include leases, trade credit, and factoring.
- Multiple Tax Benefits
You have the option to combine some of the best of the incorporation worlds.
That is by electing your single-member LLC either to get taxed as a sole proprietor, which will be the standard election or an S-corporation.
When you elect your tax treatment as a sole proprietor, it means that all your losses and profits will flow to your personal tax return.
When you elect your tax treatment as an S-corporation, all your losses and profits flow through your personal tax return.
You get the option to reduce FICA taxes if you establish a “reasonable salary” and receive the rest of the profits as dividends.
This way only your salary is subjected to FICA withholding.
Lastly, you get perks of tax benefits since you are self-employed.
Disadvantages of Forming an LLC
Even with so many benefits of forming an LLC, there are some drawbacks too, including:
- Requires Paperwork and State Filing
There will be state-needed paperwork necessary which also includes any specific industry licensing.
There will also be annual state filings along with the associated fees.
This also includes any specific industry licensing fees.
- Pay More Taxes
Other than paying the self-employed, local, state, and federal versions of FICA taxes, you may also need to shell out for state business taxes and unemployment taxes.
The cost to complete an LLC’s tax return is more compared to that of a sole proprietorship.
Is an LLC Always the Best Option?
It is obvious that an LLC has a lot more benefits than a sole proprietorship, but is it always a good idea to choose that?
You will find asset protection consultants constantly marketing to business owners that opting for an LLC is the way to go.
That said, it isn’t always the case.
In some cases, entities are better suited for a sole proprietorship.
That’s because all the extra costs of having an LLC do not provide them with any benefits significantly in comparison.
Additionally, since an LLC provides liability protection against your business’ commercial acts, there can always be some big-shot attorney who will search for any loophole in your business set up to go after your personal assets.
In some cases, courts tend not to look favorably upon single-member LLCs.
Then the question arises in legal proceedings as to whose exact interests are technically being protected against if you are your LLCs only member.
Final Thoughts
You are going to come to a crossroads when you have to choose between sole proprietorship vs LLC for online business.
Just like several other questions that arise for your business, there isn’t technically a right answer for this.
While obtaining financing or funding for your business can be quite challenging, the protections and advantages you benefit from being an LLC cannot be understated.
That said, initially, as a small online business, it’s not the worst idea to start as a sole proprietorship.
What you need to keep in mind is what your business goals are and what you’re looking to achieve ultimately.
We recommend seeking help or advice from professionals if you aren’t sure.