Confused in choosing between single member LLC vs sole proprietorship? Below, we will see the differences, pros, and cons of these businesses forms. They are similar that there is only one owner in each business, but they do have significant differences regarding the liability protection and operation.
What is a Single Member LLC?
A single member limited liability company (SMLLC) is a limited liability company that only has a single individual or entity (called a “member”) that owns all of the company’s ownership interest. A single member LLC is a legal business entity that is registered in the state where the company operates. The term “single member” is a form of recognition that the company only has one owner. Take a look at our previous post about Incorporation vs LLC to understand the characteristics of a limited liability company.
As a limited liability company, the single member LLC indeed holds all the advantages and disadvantages of a limited liability company. There are two main activities that make an owner of a single member LLC different from an owner of a corporation. First, the owner of an LLC is not an employee, so he or she does not get any salary; instead, the owner is able to take money out from the business for personal expenses as needed. Second, the owner of an LLC can put money into the business by making a capital contribution from his or her personal funds.
Benefits of a Single Member LLC
The main reason of choosing a single member LLC vs sole proprietorship is that a single member LLC can give you liability protection. When you are running a single member LLC, the debts that the business takes are not the same as the owner’s personal debts. This is a huge advantage, and it is very important. As your business grows and develops, there will be more complex financial transactions, and you don’t want to mix them up with your own personal debts. Doing so may lead to problems and financial complications.
The second advantage of a single member LLC is that you can have some flexibility in managing your federal-level taxes. You can choose the filing to be either as a corporation or as a sole proprietorship. With these choices, you can adapt the most suitable tax strategy for your specific business.
Cons of a Single Member LLC
Compared to single proprietorship, single member LLC indeed requires more formal requirements. It requires more paperwork, and you must gi to the state’s business division to file Articles of Organization or Certificate of Certification. You may also need to prepare an operation agreement, which is similar to by-laws of a corporation.
The second disadvantage of a single member LLC is that different states may have different rules and regulations for their single member LLCs. For example, in Florida, many lawyers think that it is a justified action if a creditor seeks out the owner of the business if the business is unable to pay the debts. This leads to legal uncertainty. Make sure that you check your state’s rules and regulations first before forming a single member LLC.
What is a Sole Proprietorship?
A sole proprietorship is the simplest form under which one can run a business. One big difference of single member LLC vs sole proprietorship is that a sole proprietorship is not a legal entity. It only refers to a person who is the owner of the business and is personally responsible for all of the business’s debts. Nevertheless, a sole proprietorship can run under the name of the owner of a fictitious name. The fictitious name is simply considered as a trade name, and not considered as a separate entity from the owner.
Well, the owner of a sole proprietorship usually signs contracts using his or her own name. This is because a sole proprietorship does not have any separate identity under the law. Even if the business uses a fictitious name, the owner will still have the customers write checks in the owner’s name. Sole proprietor owners are allowed to commingle personal and business properties and funds. Sole proprietorship is a very popular business form because of its ease of setup, simple operation, and low nominal cost. Many businesses are started as sole proprietorships, and are upgraded later to more complex business forms as they develop.
Benefits of a Sole Proprietorship
The only advantage of a sole proprietorship is the simplicity. It is the simplest business form, and it has simple requirements and operation rules. It only has a single tax choice. Instead of getting multiple tax filing choices as a business, you act as the business and you claim all of the assets on your tax form. Such simplicity makes the process of tax filing so much easier.
The liability is also a benefit if you are running a very simple business. Although you can establish yourself as a DBA (“doing business as”), you are still operating as the sole owner and representative. You are responsible for all actions of the company. The management tasks will be quite easier to do.
Cons of a Sole Proprietorship
As your business grows, you will need to hire more employees. When this happens, the chance of liability grows. Imagine that the owner (you) or one of the employees gets involved in a business-related accident in which someone gets injured or killed. The resulting case can be brought against the owner and against his or her personal assets, including the personal bank accounts and even retirement accounts. To avoid this problem, you will have to upgrade your business into a form with liability protection.
Factors to Consider
There are at least two factors to consider when choosing between single member LLC vs sole proprietorship. First, consider the service or product that you provide. Does it have any considerable risk of liability? If it has, you must incorporate sooner. But if the situation is only a low-risk, low-liability condition, staying as a sole proprietorship is okay.
Second, if the business is just a spontaneous capitalization on a trend instead of a long-term investment, staying as a sole proprietorship is good. On the other hand, for a long-term investment, the single member LLC is more recommended – larger businesses should consider taking the bigger business forms.
|Single Member LLC||Sole Proprietorship|
|- Separate legal entity||- The same entity as the owner|
|- Liability protection||- No liability protection|
|- Flexible tax filing||- Only has one tax filing option|
|- Has more requirements||- Much simpler|
|- Suitable for long-term business||- Suitable for spontaneous capitalization, may need to be upgraded later|
A single member LLC is a separate legal entity. It offers liability protection, and is recommended for long-term businesses and businesses with considerable risk of liability. Note that it has more requirements. On the other hand, a sole proprietorship is not a separate entity; it is bound to the owner. The main advantage is the simplicity. It is only recommended for businesses with a low-risk, low-liability situation and short-term businesses.