What is an LLC?
A limited liability company, or LLC, is a very popular U.S. structure that provides limited liability and pass-through taxation.
With an LLC, members are not personally liable for the company's debts, which protects their personal assets from being used to cover them if something goes wrong.
In addition, the LLC's profits and losses pass directly to the owners, who report them on their personal tax returns.
This type of organization is very popular in the United States because it also comes with low formation and maintenance costs, a high level of privacy and great operational versatility.
Finally, LLCs can have several owners, or just one in the case of single-member LLCs.
What is a sole proprietorship?
A sole proprietorship, on the other hand, is a business structure in which the owner is the legal entity and solely responsible for all business operations.
In this case, there is no separation between personal and business assets, which means the owner is personally liable for the business's debts and obligations.
A key feature of a sole proprietorship is that it can only have one owner; if a partner is added, it becomes a general partnership. It is especially popular among freelancers and consultants who want to simplify their tax filing.
LLC vs. sole proprietorship: a complete comparison
The decision to create an LLC or a sole proprietorship to do business in the United States and the rest of the world will depend on each particular case, but you should always take their differences into account:
Personal liability
In a sole proprietorship, there is no legal separation between the business and the owner, which means the owner is personally liable for business debts.
In the event of bankruptcy, the owner must file for personal bankruptcy, covering both personal and business debts. In addition, anyone who sues the business can go after the owner and their assets personally.
By contrast, an LLC separates the member from the business's obligations, so if the business goes bankrupt, the members do not have to cover the debts with their own resources, except in cases of fraud, negligence or personally guaranteed debts.
Taxes
On the other hand, a single-member LLC and a sole proprietorship have the same tax treatment, as pass-through entities with no corporate taxes.
This means the owners report the income on their personal tax returns and pay taxes at the personal income rate.
In addition to income taxes, both structures may have additional tax obligations, such as payroll and sales taxes.
Formation and maintenance costs
As for costs, starting a sole proprietorship is free, while creating a single-member LLC involves a cost that will depend on the state where the LLC is registered.
Likewise, limited liability companies usually carry an annual cost, as well as other expenses tied to certain documents required to operate legally in the United States.
In any case, keep in mind that an LLC's costs are not usually excessive: any small business owner or freelancer will be able to cover them without any problem.
Company management
A sole proprietorship is characterized by simple management, since a single owner makes decisions without third-party involvement. Although the owner can hire help, their main responsibility is to ensure the business runs well and is profitable.
In contrast, an LLC is slightly more complex, with a structure set out in an operating agreement, a document that describes the members' ownership, voting rights and share of profits. If it is a single-member LLC, it is almost identical to a sole proprietorship.
In LLCs, decisions and profits are usually based on each member's ownership percentage. For example, an owner of 25% of the business has a quarter of the votes and profits, adding an extra layer of organization and responsibility compared with a sole proprietorship.
Responsibilities and obligations
Finally, there is a big difference between an LLC and a sole proprietorship when it comes to paperwork and compliance requirements.
A sole proprietorship involves little initial paperwork and focuses on tax compliance. An LLC, on the other hand, has more responsibilities because it must file annual reports, draft Operating Agreements and manage ownership.
These steps are not mandatory, but they are recommended to preserve liability protection. In addition, dissolving an LLC involves additional paperwork.
Which one should I choose?
The choice between opening an LLC or creating a sole proprietorship will depend on each particular case: not all business owners or freelancers have the same characteristics, goals and needs.
However, while a sole proprietorship is cheaper and much simpler to manage, it does not provide the limited liability protection of an LLC.
At first, when a project is born, choosing one structure or the other may seem almost irrelevant. But as the business grows, whatever it is, the LLC becomes a more effective option in several respects.
Get professional advice for your business
- Experts in doing business in the USA
- Legal and accounting team
- Free first consultation
Get your questions answered now
Written by
Ignacio Navarro
Ignacio Navarro is a Certified Public Accountant, founder of Start Companies and a specialist in U.S. companies for entrepreneurs, freelancers and digital businesses in Latin America. With training in international taxation and studies at UCEMA, he advises non-resident clients on forming and maintaining LLCs, opening bank accounts, invoicing, accounting and taxes. His experience combines tax strategy, compliance and practical vision for operating in the U.S. in a simple, organized and professional way.
