Did you know that sole proprietors make up a little over 73% of small business shares in the United States? Many businesses choose to start off as a sole proprietor entity for several reasons. There isn’t too much paperwork to file and it is fairly affordable for most entrepreneurs. Sole proprietors are also quite popular due to the amount of control that the formation affords its owners. In a sole proprietorship, the owner of the business is the boss. They become responsible for everything that impacts the business, good and bad alike.
Some entrepreneurs may be comfortable knowing that they are fully responsible for their business. Others, however, may like the additional support of a safety net.
Enter the limited liability company — or LLC. There are several entity formations a sole proprietor may incorporate as, ranging from a partnership to a corporation. However, LLCs remain popular with small business owners for a variety of reasons. Let’s take a look at the benefits switching to this formation provides small businesses.
1. Access to liability protection.
One of the greatest assets an LLC provides small business owners is liability protection.
What is liability protection? This means that the business is separate from the owner. Previously, as a sole proprietor, the business was entirely associated with its owner.
Being separate through liability protection ensures the protection of the business owner’s personal assets. Creditors may not touch valuable items, like houses and cars, in the event of a liability that faces the small business. This adds to peace of mind that, in the event of an unforeseen circumstance, personal belongings will not be impacted due to liability protection.
2. Easier to calculate and pay taxes.
Sole proprietors are taxed on personal and business taxes. Remember that under this entity, a business is not a separate entity. Sole proprietors must pay taxes for the business’ profits. All income must be reported on the owner’s personal income tax return.
Oh, and a sole proprietor is also responsible for paying self-employment taxes. This covers Social Security and Medicare obligations. For example, employees at small businesses may be matched by employers for these expenses. However, under a sole proprietorship the owner is fully responsible for all taxes.
For some sole proprietors, this may feel like a bit too much tax responsibility. Is there any way they can make doing taxes easier? An LLC can help make it easier to handle your tax obligations. You may choose the entity that you would prefer to have the LLC taxed as, which include options like a partnership or an S Corporation.
Many LLC business owners often choose to tax an LLC as an S Corporation. An S Corp allows corporate income, profits, and losses to “pass-through” to shareholders. Similarly, deductions and credits may also pass-through to shareholders. According to the IRS, S Corp shareholders report the pass-through of income and losses on personal tax returns. In other words, shareholders are taxed at individual income tax rates. In conclusion, this helps avoid double taxation.
What about self-employment taxes?
What about self-employment taxes? Let’s continue with the example that an LLC chooses to tax itself as an S Corp. The LLC’s owner is officially an employee of the business. Therefore, as an employee they may draw a salary from the profits of the business. What happens to the salary the owner is able to withdraw? It is, therefore, subject to self-employment taxes.
What happens to the remaining profits? Owners may distribute remaining profits as dividends. These dividends are taxed at a lower rate than your income. In addition, you may have less tax liability. Overall, it’s a bit less expensive and time consuming to file taxes as an LLC than to file taxes as a sole proprietor.
3. There’s flexibility available in LLC structures.
Maybe you are the sole owner (commonly referred to as a member) running the LLC. Or, you might have a few other owners associated with the business. Who gets to run the show? Let’s review the types of structures available that ensure members may successfully run their LLCs.
- Single Member LLC: Only one member runs the business. For instance, this structure is ideal for LLCs with only one owner.
- Member Managed LLC: This structure allows all members to share the same amount of responsibility in how the LLC is managed and run. However, all members are treated equal under this type of LLC.
- Manager Managed LLC: Some LLC members need a little help in order to run their business. A manager managed LLC appoints a board of managers. After that, they oversee the direction and operation of the LLC instead of the members.
Is forming an LLC right for me?
Are you a sole proprietor that is uncertain about whether to incorporate as an LLC? Reach out to MyCorporation. Our team is happy to assist you in answering additional questions about LLCs.
If you decide to form an LLC, our team walks you through the formation process. In conclusion, this ensures that your business fulfills each step before it files to incorporate as an LLC.