Short answer: A sole proprietorship is the default when you do business alone: there is nothing to file and nothing to pay, but you are personally liable for every business debt and lawsuit. An LLC costs a state filing fee and some yearly paperwork, and in return it separates your personal assets from the business. By default, both are taxed the same way. For most people with clients, contracts or real risk, the LLC is worth it.
LLC vs. Sole Proprietorship at a Glance
| Sole proprietorship | Single-member LLC | |
|---|---|---|
| How it starts | Automatically, when you start doing business | File Articles of Organization with a state |
| State filing fee | None (a DBA if you use another name) | $35 in Montana to $500 in Massachusetts |
| Personal liability | You are personally liable for all business debts and claims | Your personal assets are protected from business debts and claims |
| Default federal tax | Schedule C on your Form 1040 | Schedule C on your Form 1040 (disregarded entity) |
| Self-employment tax | 15.3% on net earnings | 15.3% on net earnings, unless you elect S corp status |
| S corp election | Not available | Available with IRS Form 2553 |
| Ongoing requirements | Local licenses and taxes | Annual report or state fee, registered agent and records |
| Business bank account | Optional, can use your SSN | Required in practice, opened with the LLC’s EIN |
| Credibility with clients and platforms | Lower | Higher |
| Available to non-US residents | Not practical | Yes |
Liability: The Biggest Difference
A sole proprietorship and its owner are the same person in the eyes of the law. If the business owes money or loses a lawsuit, creditors can go after your savings, car and home.
An LLC is a separate legal entity. Business debts and claims stay with the LLC, so your personal assets are protected. That protection has limits:
- Your own actions: an LLC does not protect you from your own negligence or wrongdoing.
- Personal guarantees: if you personally guarantee a loan or lease, you owe it no matter what.
- Mixing money: paying personal bills from the business account lets a court ignore the LLC, which is called piercing the corporate veil. Keep a separate bank account and records.
Read more about common types of business legal liabilities.
Taxes: Same by Default, Different With an S Corp Election
The IRS treats a single-member LLC as a disregarded entity unless you choose otherwise. You report business income and expenses on Schedule C with your Form 1040, exactly like a sole proprietor, and pay 15.3% self-employment tax on net earnings. Both structures qualify for the qualified business income deduction.
The difference is the option an LLC gives you. An LLC can elect to be taxed as an S corporation by filing IRS Form 2553. You then pay yourself a reasonable salary through payroll and take the rest of the profit as distributions, which are not subject to self-employment tax. A sole proprietorship cannot make this election.
| Tax item | Sole proprietorship | LLC (default) | LLC taxed as S corp |
|---|---|---|---|
| Federal return | Schedule C | Schedule C | Form 1120-S plus a K-1 |
| Self-employment tax | On all net earnings | On all net earnings | Only on the salary, through payroll |
| Payroll required | No | No | Yes |
| Extra cost | None | None | Payroll service and a separate tax return |
See how an S corp election lowers self-employment tax, with the math.
Costs to Start and Maintain
Sole Proprietorship
- No state formation filing.
- A DBA (assumed name) filing if you do business under a name other than your own.
- Local business licenses and permits for your industry and city.
LLC
- A state filing fee from $35 in Montana to $500 in Massachusetts. See LLC cost by state.
- An annual report or annual fee in most states. California charges an $800 minimum franchise tax each year.
- A registered agent in your formation state.
- An operating agreement, an EIN and a business bank account.
- Local business licenses, the same as a sole proprietor.
Non-US Residents Need an LLC
A sole proprietorship is tied to you personally, so a non-US resident has no practical way to run one in the US. Banks, payment processors and marketplaces expect a US entity with an EIN. A US LLC gives a foreign owner that entity, a US bank account and access to platforms like Stripe and Amazon.
A foreign-owned single-member LLC has one extra federal filing: Form 5472 with a pro forma Form 1120, due each year the LLC has reportable transactions with its owner, including the money used to form and fund it.
For Freelancers and Side Hustles
Many freelancers start as sole proprietors because it costs nothing. An LLC becomes the better choice when any of these apply:
- Clients send contracts with indemnity clauses or ask for a business entity before they hire you.
- Your work carries risk of a claim, such as advice, design, code, events or physical products.
- You hold savings, a home or other assets you want to protect.
- Your profit is high enough that an S corp election saves more than it costs.
- You want to keep your home address and SSN off client paperwork.
Read more in our guide to the LLC for freelancers.
How to Switch From a Sole Proprietorship to an LLC
- Form the LLC by filing Articles of Organization in your state. See how to start an LLC.
- Get an EIN in the LLC’s name so banks, clients and payment platforms can identify the LLC as the business.
- Open a business bank account in the LLC’s name and move business money into it.
- Move contracts, licenses and accounts into the LLC’s name, and tell clients to pay the LLC.
- Close your DBA if you no longer need it.
For the full process, see converting a sole proprietorship to an LLC. BusinessAnywhere handles business registration in all 50 states with a $0 filing fee plus the state’s fee, and our EIN application service gets the LLC its tax ID.
FAQs
Is it better to be a sole proprietor or an LLC?
An LLC is better if you want to protect your personal assets from business debts and lawsuits, need a US entity as a non-resident, or plan to elect S corp taxation. A sole proprietorship fits a low-risk side business that is testing an idea and has no assets to protect.
What is the biggest disadvantage of an LLC?
Cost and upkeep. You pay a state filing fee, an annual report or fee in most states and a registered agent, and you must keep business money separate. In California, the $800 minimum franchise tax applies every year.
At what income is an LLC worth it?
Liability protection is worth it at any income if your work carries risk or you have assets to protect. The tax benefit comes from an S corp election, which pays off once your profit is high enough that the self-employment tax you save exceeds the cost of payroll and an extra tax return. Ask your accountant to run the numbers for your profit.
What if your LLC makes no money?
You still owe your state’s annual report or fee and must keep a registered agent. A US-owned single-member LLC with no income or expenses has nothing to report on Schedule C. A foreign-owned single-member LLC still files Form 5472 for any year with reportable transactions.
Does an LLC pay more taxes than a sole proprietor?
No. A single-member LLC is taxed the same as a sole proprietorship by default. The only extra costs are state fees, such as annual reports or California’s $800 franchise tax.
Can a sole proprietor become an LLC?
Yes. Form an LLC with your state, get an EIN in the LLC’s name, open a business bank account and move your contracts and accounts into the LLC’s name.
