If you are starting a new business, one of the things you’ll need to consider is what type of entity structure you want to form.
In fact, it’s one of the most important decisions you’ll make.
Your entity type can impact your taxation arrangement, management structure, and even operational processes. In a nutshell, it has major implications for your business.
That’s why it’s a decision you must not make in haste.
Carefully consider your requirements and how each entity type will affect your business. To help you make an informed choice, we’re going to discuss the details of the two of the most common entity types — Sole Proprietorships and LLCs.
Let’s compare them on three main parameters: Ownership arrangement, ease of formation, and tax implications.
1) Ownership Arrangement
A Sole Proprietorship is always owned by only one person. They may employ other people but there is only one owner. Due to this structure, the owner has complete say over all decisions related to the business.
When it comes to LLCs, they can have one or multiple owners. In an LLC, owners are referred to as “members.”
Foreign entities, individuals, and other LLCs can all be members of an LLC. However, insurance companies and banks can not become LLC members.
2) Ease of Formation
One of the biggest advantages of a Sole Proprietorship is that it is easy to form. Owners can operate the business under their own name. If they do so, there are no formation requirements.
Alternatively, you can run it under a fictitious name as well. For this, you can apply for a DBA (Doing Business As). You can file for it in your state and will be required to pay a special filing fee.
Now, let’s talk about the formation process of an LLC.
To form an LLC, you will need to file Articles of Organization with the Secretary of State. Additionally, you will have to make an LLC Operating Agreement. This agreement should outline the roles and responsibilities of all members and managers.
For the process completion, you will need to pay a state filing fee as well. The fee varies by state.
It can be anywhere between $50-$500 in different states in the United States of America. Along with this, you will need to pay annual filing fees as well in most states.
3) Tax Implications
The taxation structures of both Sole Proprietorship and LLCs have one feature in common: pass-through taxation. However, they may affect business owners differently.
The pass-through taxation system for Sole Proprietorship makes it necessary for owners to report their business income on their individual tax returns. Additionally, you’ll be required to pay self-employment tax to the federal government as well.
In LLCs, the pass-through taxation structure is designed such that profits and losses of the company pass through to the individual tax returns of each LLC member.
You also have the flexibility to get your LLC taxed as a Corporation if you wish.
Sole Proprietorship or LLC — whichever you pick, make sure you study all the tax implications thoroughly before moving ahead with the formation of your entity.
Want to know more details about forming LLCs and Sole Proprietorships?
Check out this infographic by GovDocFiling which highlights all the important points that you need to know.