Do I Need to Form an LLC?

Starting a new business is exciting and at the same time, full of unknowns and challenges. One common question that most entrepreneurs ask when they start their journey is if they need to form an LLC. In this month’s blog, we will be discussing the difference between a sole proprietorship and a single-member LLC. Deciding how you create and file your new company is the critical first step to setting up your operation.

There are benefits and challenges with both sole proprietorship and single-member LLC business structures. Before we dive into the pros and cons, let’s define which each option is.

Sole Proprietorship is defined as a type of unincorporated entity that is owned by one individual only.

Single-Member LLC (SMLLC) is defined as a formal business structure with only one owner which offers the personal liability protection of a corporation. A standard LLC has more members and is beneficial for businesses where several members share the financial and business burdens.

 

Let’s look at the Pros and Cons of each to better understand their benefits to new businesses.

 

Sole Proprietorship

Pros:

• It’s the easiest way to start your business.
• There are little to no filing fees
• Formal agreements aren’t required.
• The popular option for those who want to be their own boss.
• Business deductions may be taken when filing annual tax returns.

 

Cons:

• All assets are subject to the legal and business claims of customers and creditors. You are not protected as you would be under an LLC.
• The net business income is taxed on the sole proprietor’s individual income tax rates.
• Not eligible for venture capital. It is much more difficult to raise capital.
• Insurance coverage can be expensive depending on where you operate and what type of business you run.
• In many circumstances, you cannot roll your Sole Prop into an LLC. You would be required to create a new business under the proper LLC.

 

Single Member LLC

Pros:

• Pass-through taxation where profits are passed along to its members (owners), who are responsible for reporting their income on their personal tax returns.
• Business deductions may be taken when filing annual tax returns.
• The owner is seen by the government as self-employed and the income flows to the owner as a distribution rather than a salary. Self-employment taxes are still relevant for SMLLC owners.
• SMLLC’s are not required to have a Board of Directors and shareholders.
• SMLLC’s are a separate entity from the owner, providing legal protection of personal assets. If you are sued or found negligent and must pay, your personal assets (such as your home) are protected from legal action.

Cons:

• It can be more difficult to obtain credit, raise venture capital, and determine the value of your LLC compared to a corporation.
• Depending on which state the SMLLC is registered, filing and renewal fees can be significant. For example, California’s filing fee is $70, and the yearly renewal fee is $800. On the lower spectrum, Colorado’s filing fee is $50, and the yearly renewal is $10. New Jersey falls somewhere in the middle, with an initial filing fee of $125, and annual renewal fees of $75. To see the current filing and renewal rates for all states in 2021, check out this research.
• The net business income is taxed on the same basis as a sole proprietor, based on the sole proprietor’s individual income tax rates.

 

Now that you’ve explored the differences between the structures you may still be asking if you should form an LLC. Deciding on which way to create and file your business is not always black and white. It is important to discuss things with your tax attorney/CPA and/or your business attorney. There are several ways to create your company besides these two, and we encourage you to look at the entire landscape of options.

 

There are many challenges to starting and running a business. Defining your business structure is just the first in a long To-Do list! We have several blog posts that speak to the fundamentals of business contracts, which tend to be the lifeblood of most businesses. Check out our 4-part series on contracts, where you can learn the essentials of writing contracts that will help you run and protect your business.

 

We are here to help. Please reach out to us if you have any questions about how you might create your business as well as if you need legal counsel for supporting your future endeavors.

 

 

 

Disclaimer: Please note that this blog is informational only and is not meant to provide legal advice. Each situation is different and requires informed care and decisions. Please seek guidance from a licensed attorney before proceeding with your transaction.