LLC vs sole proprietorship

The tax argument you'll hear is mostly wrong

A single-member LLC is what the IRS calls a disregarded entity. That phrase is doing exactly what it sounds like: for income tax, the IRS looks straight through the company at you. The profit goes on Schedule C of your 1040, exactly where it would have gone if you'd never filed anything. Same forms, same rate, same quarterly estimates.

So when a formation service implies an LLC will lower your tax bill, ask which tax. It won't be income tax and it won't be self-employment tax, because neither one knows or cares whether you filed with the state.

What can change your tax bill is electing S-corp treatment, and that's a separate decision you make on top of the LLC rather than because of it. It has its own arithmetic and its own break-even, and it only starts to pay once profit is high enough to cover running payroll for yourself.

What you're actually buying: the wall

A sole proprietor and their business are the same legal person. A judgment against the business is a judgment against you, and it can reach your savings, your car, and in most states some portion of your home. There is no separation to argue about, because there is nothing separate.

An LLC is its own legal person. It signs its own contracts, owes its own debts, and gets sued in its own name. When it loses, the creditor's claim generally stops at whatever the company owns. That's the whole product.

This matters in direct proportion to how much can go wrong. A freelance copywriter with no employees, no premises and no inventory is carrying a genuinely small risk. A contractor on other people's roofs, anyone with staff, anyone whose product goes in a mouth or on skin, and anyone signing a commercial lease is carrying a large one.

The wall is not automatic, and people knock it down themselves

Courts will disregard the LLC and come after the owner personally when the owner never really treated it as a separate business. The legal phrase is piercing the corporate veil, and in single-member companies it usually comes down to money moving in and out of one bank account.

The practical version is short. Open a business bank account and run every dollar of business income and expense through it. Pay yourself by transfer, not by buying groceries with the business card. Sign contracts in the company's name with your title, not just your name. Keep the annual report filed so the company is in good standing.

None of that is difficult, and all of it is skipped constantly. An LLC used as a bank account with a nicer name provides about as much protection as one that was never filed.

The costs, honestly

A sole proprietorship costs nothing. You may still need a local business licence and, if you trade under a name that isn't your own, a DBA — but there's no formation filing and no annual report.

An LLC costs the state's filing fee once, and then whatever that state charges to keep it alive: an annual or biennial report, and in a handful of states a franchise tax or minimum fee that arrives whether or not you made money. Our by-state table lists what each state charges to form, with the date the figure was last checked against the agency's own page.

It's the recurring column that catches people out. The formation fee is a one-off you've already budgeted for. The report is the one that shows up every year forever, and the one people forget until the state dissolves the company.

A reasonable way to decide

Form the LLC if the business can plausibly be sued, can take on debt it might not cover, has employees or contractors, holds a lease, handles other people's money or data, or makes something people consume. Form it also if a client or a bank has told you they need to contract with an entity, which happens more than the liability argument does.

Stay a sole proprietor a while longer if you're testing whether the thing works at all, revenue is small, the only asset is your laptop, and nobody has asked. You can form the LLC later, and forming it later costs the same as forming it now.

What you shouldn't do is form one to look established and then run it out of your personal account. That's the version that costs money every year and protects nothing.

Common questions