Sole Proprietor or LLC? What New Business Owners Need to Know

Starting a business comes with a long list of questions: What should I name it? Who’s my ideal customer? How will I market myself? But before you dive into branding or building a website, there’s one foundational choice you can’t afford to skip—choosing your business structure. For most new business owners, this boils down to a common fork in the road: Should I operate as a sole proprietor or form an LLC?

It might sound like a dry legal detail, but this decision can impact your taxes, your personal risk, and your future growth. The good news? Once you understand how each option works, the right path usually becomes clear.

Understanding the Basics: What Is a Sole Proprietor?

A sole proprietorship is the simplest way to start a business. It’s not a formal legal entity—you don’t need to file paperwork or pay registration fees to become one. In fact, the minute you start selling a product or offering a service on your own, you’re automatically a sole proprietor by default.

Key Characteristics of a Sole Proprietorship

• Easy to start: No formal paperwork required (aside from local licenses or permits).
• Tax simplicity: Income is reported on your personal tax return using Schedule C.
• No separation of personal and business assets: You are personally liable for any business debts or legal actions.
• No formal structure: It’s just you running the show, with total control.

This model works well for low-risk ventures and side hustles, especially when you’re just testing the waters. But it comes with limitations—and some significant risks.

The Risk Factor: Why Sole Proprietorships May Not Be Enough

Let’s say you’re a freelance graphic designer working from your home office. You land a few clients, and life is good—until a client accuses you of breaching a contract and threatens legal action. As a sole proprietor, you don’t just risk losing your business income—you could be on the hook personally. Your savings, car, and even your home could be at risk.

That’s the catch with sole proprietorships: There’s no legal separation between you and your business. You are the business. While that simplicity can be a blessing at the start, it can quickly become a burden as your business grows—or if anything goes wrong.

What Is an LLC and How Is It Different?

An LLC, or Limited Liability Company, is a formal legal business structure recognized by your state. It requires filing articles of organization and paying a small registration fee, but what you get in return can be a game-changer.

Key Characteristics of an LLC

• Liability protection: Your personal assets are typically shielded from business debts and lawsuits.
• Credibility: Operating under an LLC often makes your business appear more professional to clients and partners.
• Tax flexibility: By default, an LLC is a pass-through entity (like a sole proprietorship), but you can elect S-Corp taxation if it benefits you.
• Scalability: LLCs allow for multiple members and more formal operating structures—ideal if you plan to expand or bring on partners.

While forming an LLC involves some initial paperwork, the benefits often outweigh the costs—especially once your business starts generating steady income or taking on higher levels of risk.

Comparing Costs: What’s the Financial Difference?

Let’s talk dollars and cents. Sole proprietorships have no formation cost—unless you’re required to get a business license or permit in your city or county. On the other hand, forming an LLC typically involves:

• A state filing fee (usually $50–$300, depending on your state)
• Optional costs like a registered agent service or legal help
• Ongoing requirements like annual reports or franchise taxes in some states

That said, forming an LLC is a one-time expense for a major benefit: protecting your personal finances. For many business owners, it’s not an added cost—it’s a smart investment.

Which One Pays Less in Taxes?

Taxation is another area where people get stuck. Here’s how it works:

• Sole proprietors pay income tax on all profits, plus self-employment tax (around 15.3%).
• LLCs are taxed the same way by default, but you can choose to be taxed as an S Corporation, which may reduce your self-employment tax burden if your income grows.

So early on, the tax difference between a sole proprietorship and a single-member LLC is negligible. But as your profits rise, LLCs offer more flexibility—and potential savings.

Real-World Examples: Who Should Choose What?

Let’s break it down with some practical scenarios:

• Taylor the dog walker: Just starting out, earning under $1,000/month, no employees, low risk. Starting as a sole proprietor might make sense initially.
• Jess the event planner: Booked out months in advance, signing contracts, handling client deposits. Forming an LLC is likely the safer move.
• Omar the Etsy seller: Gaining traction, looking to trademark a brand name and scale up. An LLC will provide protection and establish credibility.

As a rule of thumb, if your business involves contracts, client interactions, employees, inventory, physical space, or legal exposure—it’s time to form an LLC.

Forming an LLC: Easier Than You Think

The idea of “starting a company” can sound intimidating, but forming an LLC is surprisingly simple—especially with the right help. Most states let you file online in under 30 minutes. You’ll typically need:

• Your business name (make sure it’s available)
• A registered agent (someone who can receive legal documents)
• An operating agreement (outlining how your LLC will be managed)

If the paperwork feels overwhelming or you’re worried about missing something, consider using a professional service that handles LLC formation for you. It’s affordable, efficient, and saves time you could be using to grow your business.

Can You Start as a Sole Proprietor and Switch Later?

Absolutely. Many entrepreneurs begin as sole proprietors and later form an LLC once their income grows or the business becomes more complex. However, switching structures midstream means updating bank accounts, contracts, tax IDs, and more—so it’s often easier to start with the right foundation from the beginning.

That’s why we often say: if you’re serious about your business, protect it from day one.

Choose Based on Where You’re Going, Not Just Where You Are

If you’re starting out small, with minimal risk and income, a sole proprietorship may be fine for the short term. But if your business is something you plan to grow—or if you want to protect your personal assets from day one—forming an LLC is the smarter move.

Choosing between a sole proprietorship and an LLC isn’t about right or wrong. It’s about risk, growth, and your vision for the future. And when you’re building something important, that foundation matters more than you might think.