Sole Proprietorship vs. LLC: Key Insights You Need to Know

While starting your own business is certainly exciting, it often requires some not-so-exciting decisions, like choosing a business structure.

One of those decisions could be whether to launch as a sole proprietorship or an LLC. This decision can significantly impact your compliance obligations, how you pay taxes, and your personal liability.

Compare the differences between sole proprietorships and LLCs to help decide which type suits your business.

What is a sole proprietorship?

A sole proprietorship is an unincorporated business owned by a single individual. The most basic type of business, a sole proprietorship has no legal separation between entity and owner. Your business profits pass through to your personal income tax return and are taxed at the individual rate. 

Unless you’ve taken steps to legally establish your business differently, it’s automatically considered a sole proprietorship by default. This makes it a go-to choice for self-employed people and low-risk businesses like print-on-demand companies.

Benefits of a sole proprietorship

Here are some of the main benefits of running your business as a sole proprietor: 

• Complete control. As the sole owner of your business, you make all of your own decisions and can pass down your business to heirs of your choosing. 
• Easy. There’s no formal paperwork to fill out to form a sole proprietorship. Your business is considered as such automatically until or if you change the designation. 
• Keep all your profits. As the sole owner, you receive all of the profits (minus taxes, of course).
• Simple tax filing. Sole proprietors only pay personal income taxes on the business profits. 

Read our in-depth guide to the advantages and disadvantages of operating a sole proprietorship to learn more.

Pro tip: Laws for sole proprietors vary by state and nature of business. It’s always best to check with your local jurisdictions to find out the requirements for setting up your sole proprietorship and noting any necessary tax filings, licenses, or permits that pertain to your specific business.

What is a limited liability company (LLC)?

An LLC, or limited liability company, is a business structure that can be owned by one person or multiple partners (called members). Think of it as a hybrid: it gives you the legal protection of a corporation but the tax simplicity of a sole proprietorship. While you can have multiple members, the most basic type is a single-member LLC—just you running the show, but with better protection than a sole proprietorship.

LLCs are formed in the state in which they operate and typically require you to get a federal employer identification number (EIN) and complete paperwork such as certificates of formation or articles of organization. Documentation requirements can vary by state.

Benefits of an LLC

Here are the primary advantages of forming a limited liability company: 

• Your personal assets are safe. If the business faces legal issues, your personal assets (like your car or house) won’t be at risk, because the business is legally separate from you, the individual.
• You can choose how to be taxed. Whether you choose to be taxed like a corporation or as an individual is up to you. If you so choose, your profits still flow straight to your personal tax return, making taxes pretty straightforward.
• You may enjoy more retirement benefits. In regard to retirement planning, LLC members can establish retirement accounts like SEP IRAs, SIMPLE IRAs, or Solo 401(k)s, potentially allowing for higher contribution limits than traditional employee retirement accounts.
• You can build separate business credit. Having a good business credit score can improve your ability to secure loans for your small business. 

Learn more about the advantages of forming an LLC.

LLC vs. sole proprietorship: What’s the difference?

LLCs and sole proprietorships can appear similar in many ways. A single-member LLC resembles a sole proprietorship because it also has one owner and is generally taxed the same.

Despite similarities, there are key differences between the two business structures. Here’s a closer look at how they differ, with the caveat that it’s always wise to consult a business tax professional when starting a new business:

Liability

LLC

• Acts as a legally separate entity from the owner
• Shields personal assets (house, car, bank accounts) from business liability claims
• Protects owner from personal liability for business debts
• Protection can be lost if the owner engages in dishonest practices (known as “piercing the corporate veil”)

Sole proprietorship

• No legal separation between owner and business
• Personal assets are exposed to business liability
• Owner is personally responsible for all business debts
• No personal legal protection from business-related lawsuits

Learn more: How To Get a Business License

Taxes

LLC

• Offers flexible tax treatment options, similar to an S corporation or C corporation
• Tax structure can be optimized based on business needs
• Requires consultation with a corporate tax professional for optimal strategy

Sole proprietorship

• Pass-through taxation only
• Business income reported on personal tax returns
• Must pay self-employment taxes (15.3%)
• Quarterly estimated tax payments required

Learn more: How To File Small Business Taxes

Costs

LLC

• Higher initial setup costs ($50–$150)
• Ongoing state filing requirements like annual reports ($50–$500), “doing business as” DBA registration, and state-specific business licenses
• Additional compliance costs
• More complex regulatory requirements

Sole proprietorship

• Minimal to no startup costs
• Limited ongoing expenses, like business name renewal (if applicable)
• Basic licensing fees
• No state reporting requirements
• Lower administrative burden

Learn more: How To Register a Business

Funding

LLC

• Broader access to financing options like business loans, crowdfunding, and investment capital
• Viewed as lower-risk by lenders
• Can add business partners/investors
• More attractive to potential investors

Sole proprietorship

• Limited financing options
• Usually restricted to personal loans
• More difficult to secure business funding
• Cannot add business partners without changing structure

Learn more: How To Pitch Ideas To Get Funding

Management and control

LLC

• Flexible management structure
• Can operate as single-member or multi-member
• Option to add members later
• Shared control possible with multiple members

Sole proprietorship

• Single owner only
• Complete control over business decisions
• Cannot add partners without changing structure
• Owner responsible for all aspects of business

Learn more: How To Manage a Business for Long-Term Success

Legal requirements

LLC

• Formal state registration required
• Unique business name requirements
• State-specific business formation rules
• Compliance requirements like operating agreements

Sole proprietorship

• Minimal legal formation requirements
• May need basic business licenses
• Simple registration process
• Few ongoing legal obligations

Learn more: Ecommerce Laws and Regulations to Know for Selling Online

Credibility 

LLC

• Projects professional image
• Higher perceived legitimacy
• More attractive to potential partners
• Demonstrates business commitment
• Preferred by many investors

Sole proprietorship

• May be perceived as less established
• Lower perceived credibility with investors
• More informal business structure
• May limit growth opportunities

Learn more: How To Start An LLC: Everything You Need to Know

When should you form a sole proprietorship?

Choosing your small business structure is an important decision. If you’re still on the fence about forming a sole proprietorship or an LLC, take a minute to consider the following criteria:

• Your business is low risk. If your business is low risk, like freelance writing or consulting, you may not need the liability protection offered by an LLC.
• You’re testing a new business idea. Creating and maintaining an LLC takes time and money. If your business idea is in the early stages, it’s probably easier to continue as a sole proprietorship until you get more traction. You can always convert your business into an LLC down the road.
• Your business is short-term. Say you’re running a side hustle as a floral designer in the summer. A sole proprietorship may be more suitable versus forming an LLC. 

When should you form an LLC?

If none of the criteria above match your business needs, an LLC might be a good option for you. Here’s what to consider:

• Your business has some risk. If you’re opening up a retail store or managing bookkeeping for companies, the protection an LLC offers can be worth it.
• You plan to grow your business. If you plan to get outside investment or eventually want to add partners, an LLC can easily accommodate new members and investors. It’s also easier to navigate state regulations with an LLC if you plan to operate in another state. 
• You want a professional business image. Forming an LLC can make your business appear more established to customers, suppliers, and investors.

Tax implications of sole proprietorships vs. LLCs

Here are some of the tax advantages and disadvantages to keep in mind as you set up your business: 

Self-employment tax considerations

Both sole proprietors and LLC owners must pay self-employment tax, which is basically Social Security and Medicare taxes combined. The tax rate is 15.3% of net earnings. 

The main difference? Sole proprietors are stuck paying the full amount directly, while LLC members who elect to be taxed as corporations can split this burden by paying themselves a salary and having their business cover half.

Deductions available for sole proprietorships

As a sole proprietor, you can write off any legitimate business expense. Common small business tax deductions include:

• Your home office (as long as it’s actually used just for work)
• Business travel and meals
• Equipment and supplies
• Insurance premiums
• Marketing costs
• Professional services like accounting or legal fees

That said, you need to be super careful about keeping your personal and business expenses separate, even though they technically flow through to your personal tax return on Schedule C.

Deductions available for LLCs

LLCs get all the same deductions as sole proprietorships. You just have more flexibility in how you handle them. 

If you’re set up as a single-member LLC, you’ll claim deductions similar to a sole proprietorship. However, if you choose to be taxed as a corporation, you can:

• Split income between salary and distributions to potentially save on self-employment taxes
• Take advantage of retirement plan options that might not be as readily available to sole proprietors

The big advantage of an LLC is that clean separation between personal and business finances makes tracking deductions way easier. Plus, if you get audited, having that clear divide can help you avoid headaches with the IRS.

Liability protection: Sole proprietorship vs. LLC

The key difference between a sole proprietorship and an LLC lies in liability protection. In a sole proprietorship, your personal assets (like your house and savings) are completely exposed to business risks. If someone sues your business or it goes into debt, your personal assets are fair game.

An LLC creates a legal barrier between your personal and business assets. If your business faces lawsuits or debts, your personal assets are typically protected. However, this protection can be lost if you mix personal and business finances or fail to maintain proper records.

Convert your sole proprietorship to an LLC

Converting your sole proprietorship to an LLC involves several key steps:

1. Choose a unique name for your LLC. Choose your LLC name carefully, as a good one can positively influence a customer’s first impression of your brand and set you apart from the competition.
2. File articles of organization with your state’s business office. You’ll need to pay a filing fee, which varies by state. Visit your state’s Secretary of State website for details.
3. Select a registered agent. There are many third-party services to help you register.
4. Create an operating agreement. This will include primary details about your business operations. 
5. Obtain a new EIN from the IRS. You can apply for one through the IRS website.
6. Update everyone on the change. Update your business accounts, licenses, and permits to reflect the new LLC structure. Update your marketing materials with the new LLC name. Don’t forget to inform customers and vendors about the change as well.
7. Transfer assets. Transfer business assets to the LLC and register for state taxes if required.

State laws vary, so it’s wise to consult with a lawyer or accountant for specific advice tailored to your situation before you start an LLC.

Move forward with your new business

Incorporating a business makes it official in the eyes of the government. You protect your personal assets, build credit for your company, and, in some cases, enjoy lower taxes. This can make an LLC more appealing than a sole proprietorship—especially as your company grows. 

Whether you choose to form an LLC or a sole proprietorship, transforming your idea into a real, official business ultimately is up to you.

DISCLAIMER: These guides are for informational purposes only and do not constitute professional legal or tax advice. Please consult independent legal advice and your own tax advisers for information specific to your country and circumstances. Shopify is not liable to you in any way for your use or reliance on these guides.