Sole Proprietorship vs LLC-Know the Difference

When you're selecting the business structure for your small business, you'll need to know what the benefits and primary differences are. The entity for your business determines how you pay your taxes, and also the type of responsibilities under your wing if a situation of liability were to arise. Most business owners begin as sole proprietors, but can easily transition into an LLC structure for a variety of benefits. Industry liability is a key factor in the decision process; how much are you willing to be personally liable for, and how much would you rather have become a part of the business? When asking these questions, taking a look at the pros and cons of each type is a good way to learn more.

The advantages and disadvantages vary by the state you live in, so it's important to consult with an attorney or accountant about the specific privileges and conditions. Here's a look at the benefits of an LLC:

• Ongoing tax benefits as long as there is more than one member
• Personal protection from LLC liabilities and the LLC itself
• Ability to deduct 100% of health insurance premiums paid
• The bottom-line profit is not considered earned income, so it does not incur self-employment tax

Here's a look at the benefits of sole proprietorship:

• Filing taxes involves a simple self-employment income tax form
• No fees or registration requirements
• No payroll set-up
• Setting up a separate business account for accounting and tax purposes

You may want to transition to the LLC status after a period of sole proprietorship for a few key reasons. First, a sole proprietorship will make you personally liable for all debts and incidents that are a result of your company. This means that if the company goes bankrupt or incurs excessive debt, everything will show up on your personal credit report and records. An LLC would ‘file' these conditions independently, and not require you to pay back the debt from personal funds. It's important to remember that an LLC is considered a separate legal entity, and would generally assume these risks and assets.

A sole proprietorship also limits your ability to raise capital; most investors will make an attempt to learn more about your business if it has an LLC status. Business teams, lawyers, accountants, and other professionals in your industry will take your business more seriously if you have an established entity.

When it comes to taxes, however, a sole proprietorship still offers the most benefits. A sole proprietor reports all business profits on the Schedule C, and does not have to worry about complicated forms issued to corporations and other entities. By not having to worry about payroll and payroll taxes, you can also save on income taxes and keep the profit. Finally, healthcare reimbursement arrangements (HRAs) can be extended to your spouse, and then deducted for self-employment tax purposes as a reimbursement. This can offer significant tax savings in the long-term, but it's important that all healthcare plans are extended to all ‘employees' or family members.

Identifying the appropriate entity for your new startup is a necessary step as you grow and bring in revenue. Considering your tax opportunities, settling your liability clauses, and determining how you will manage health insurance benefits are all part of the decision-making process.