LLC vs. Sole-Proprietorship

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Limited liability companies, known as LLCs, are business structures in the United States where the owners are not personally liable for the company's debts or liabilities. This form of business entity is incredibly helpful if you are looking to avoid personal liability for business debts or assets. It can allow you to separate your personal life from that of your business, and give you the freedom to make different tax choices.

If you are forming a business as one single owner and operator, then you also have the opportunity to form your business as a sole proprietorship. There are benefits and disadvantages to forming both in New Mexico. It is important to weigh the pros and cons of each before making your ultimate decision on how you would like to run your business.

Advantages & Disadvantages of LLC


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The only disadvantage to forming an LLC versus staying as a sole proprietor is that there is some added complexity in formation. There are also maintenance costs involved as well. Despite this, the advantages far outweigh the disadvantages of forming an LLC.

  • Tax savings can pay for formation costs
  • Liability protection to prevent personal assets from being seized due to business debts
  • Privacy (if formed anonymously)
  • More professional appearance afforded to an LLC versus a sole proprietorship
  • More tax flexibility due to being able to elect taxation as an LLC

What is a Sole Proprietorship?


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Also referred to as a sole trader or a proprietorship, sole proprietorships are unincorporated businesses with one owner. Sole proprietors pay personal income tax on all profits earned from the business. Essentially, a sole proprietorship is one single person doing business on their own.

Advantages & Disadvantages of Sole Proprietorship

Typically with a sole proprietorship there is a potential to pay more in taxes due to everything being earned income. There is also unlimited liability. If your business is sued it is the equivalent of you being sued.

It may also be difficult to grow or raise money without being under the guise of an LLC. This is because you will not be given a business EIN, and you will not be viewed as being professional as compared to an LLC.

Despite this, there are no formation costs or compliance costs when it comes to a sole proprietorship. You can simply set up your business and pay taxes each year without being required to do much else.

What is the Difference Between the Two?


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Generally, sole proprietors own a small or part-time business. Most often these businesses do not have employees. This means that it costs nothing to establish a sole proprietorship.

When it comes to an LLC, you can see different parts of both a sole proprietorship and corporate that come together. This allows the liability protection of a corporation with the tax advantages of a partnership.

The Start-Up Process

Starting a sole proprietorship is as simple as picking a service or product, and marketing it. You do not need to register your name, or do any legal paperwork. If you do want to use a different name you will need to file for a DBA. Otherwise, you can simply start your business.

LLCs require a lot more work to start-up, including:

  • Name registration with “LLC” or “Limited Liability Company” in the name
  • Drafting an operating agreement to document member and manager rights and duties.
  • File certain forms with the New Mexico Secretary of State
  • Pay a $50 filing fee
  • Acquire any mandatory licenses or permits

Funding

It can be difficult for a sole proprietorship to obtain funding. This is because it is not considered a real business, but rather a sole proprietor (one person). LLCs are considered business entities. This means that you can easily walk into a bank and obtain funding through a business loan.

Managing and Operating

In an LLC, the business can be owned by one or more members. Although the members usually manage an LLC, they do not have to. LLCs can legally appoint a manager to handle the day-to-day operations. This is outlined in a legal document known as an operating agreement.

Sole proprietorships are run by you and you only. Sole proprietors typically do not have employees, and the entire business is run by one person.

Liability

Your personal assets are considered protected when it comes to an LLC. If business debt collection or other claims were to occur, such as your company being sued, your personal assets would be protected. This means creditors would not be able to touch your home, car, or personal bank accounts.

As a sole proprietorship, there is no separation between you and the business. All of the profits are yours, but so are the debts and obligations. If you have employees and they cause issues you will also be held responsible for their liabilities as well.

LLC & Sole Proprietorship Taxation


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Operating your business as a sole proprietor means that you will also be taxed as a self-employed person. Therefore, the income of your business is also your personal income. This means you will be taxed no different than years earlier.

LLCs are a different story. LLCs may choose how to be taxed. This is called “election.” An LLC may make an election to be taxed as a disregarded entity (similar to a sole proprietorship), partnership, corporation, or s-corp. If such an election isn’t made, the LLC will be taxed as either a disregarded entity (essentially a sole proprietorship) or a partnership, depending on the number of members it has.

Should You Start an LLC or Sole Proprietorship


If you are looking for liability protection and flexibility, then an LLC may be the best option for you. Otherwise, if you are looking for less formality, unlimited control, and an easy setup, a sole proprietorship might be the best option. Make an informed decision for you and your business, based on which will benefit you most now, but also in the long run. As a sole proprietor, you can always transition to an LLC later on.

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