LLC vs sole proprietorship: which is right for your business?

Quick answer: A sole proprietorship is the default when you start working for yourself — no paperwork, no fees, and profit goes on your personal tax return — but you are personally liable for business debts and lawsuits. An LLC costs about $50–$500 to form (plus $0–$800+ a year depending on the state) and separates your personal assets from the business. Taxes are the same by default for a single-member LLC; the main reasons to form one are liability protection, credibility and the option to elect S-corp taxation later.

Key takeaways

• Both pay self-employment tax (15.3%) on profit by default — an LLC alone doesn't cut taxes.
• LLC protection only works if you keep business and personal money separate.
• State costs vary a lot: California charges $800 a year; some states charge $0–$50.
• Once profit reaches roughly $40,000–$60,000+, an S-corp election may save self-employment tax.
• Domestic US companies no longer need to file BOI reports with FinCEN after the March 2025 rule change.

Choosing a business structure is one of the first decisions you make as a freelancer, consultant or small business owner. This guide compares a sole proprietorship and an LLC on protection, taxes, costs and paperwork — with examples — so you can decide what fits now and when to switch.

#Side-by-side comparison

#Liability: the main reason to form an LLC

As a sole proprietor, you and the business are the same person legally. If a client sues, a customer is injured, or the business can't pay a debt, creditors can go after your personal assets.

An LLC creates a separate legal entity. In general, business debts and lawsuits stay with the LLC. But protection has limits:

• You're still liable for your own negligence or professional mistakes — that's what professional liability (E&O) insurance is for.
• Personal guarantees on loans or leases make you liable anyway.
• Courts can "pierce the corporate veil" if you mix personal and business money, don't keep records, or underfund the business.

Tip: An LLC and business insurance work together. For many freelancers, general liability and professional liability insurance give more practical protection than the LLC alone.

#Taxes: the same — until you elect S-corp

By default, a single-member LLC is taxed exactly like a sole proprietorship: profit on Schedule C, plus self-employment tax on Schedule SE. Multi-member LLCs are taxed as partnerships (Form 1065, K-1s).

The S-corp option

An LLC can elect to be taxed as an S corporation (Form 2553). You then:

• Pay yourself a reasonable salary (with payroll taxes), and
• Take the rest as distributions, which aren't subject to the 15.3% self-employment tax.

Example: Your LLC earns $100,000 profit.

• Default: self-employment tax ≈ 15.3% × 92.35% × $100,000 ≈ $14,130.
• S-corp: you pay yourself a $60,000 salary → payroll taxes ≈ $9,180; the other $40,000 is a distribution. Savings ≈ $4,950 — minus payroll service and extra tax-prep costs (often $1,000–$3,000 a year).

S-corp election usually starts to make sense once profit is roughly $40,000–$60,000 or more — talk to a CPA, as "reasonable salary" rules matter.

The QBI deduction

Both sole proprietors and LLC owners can usually claim the Qualified Business Income (QBI) deduction — up to 20% of qualified business income, subject to income limits — which was made permanent in 2025.

#What an LLC costs in popular states

Fees change — check your Secretary of State website. You usually register the LLC in the state where you live and work; forming in Delaware or Wyoming doesn't avoid your home state's fees if you do business there.

#How to form an LLC (step by step)

1. Choose a name and check it's available on your state's business search.
2. Pick a registered agent — yourself (with a physical in-state address) or a service ($50–$300/year).
3. File Articles of Organization online with the Secretary of State and pay the fee.
4. Write an operating agreement — required in some states, wise in all.
5. Get an EIN free from the IRS at irs.gov (takes minutes online).
6. Open a business bank account and keep all business money there.
7. Get local licences and permits your city, county or industry requires.
8. Register for state taxes if you sell taxable goods or have employees.
9. Calendar annual reports and fees so the LLC stays in good standing.

Good to know: After FinCEN's March 2025 interim rule, US-formed companies and US persons are exempt from Beneficial Ownership Information (BOI) reporting under the Corporate Transparency Act. Foreign companies registered to do business in the US may still have to file.

#When a sole proprietorship is fine

• You're testing an idea or have low income from a side hustle.
• Your work has low liability risk (writing, design, tutoring) and you carry insurance.
• You want zero setup cost and paperwork for now.
• You'll revisit the decision once income grows.

#When to form an LLC

• You have clients, contracts or physical work that could lead to lawsuits.
• You have employees or contractors.
• You hold significant personal assets (a home, savings).
• Clients or platforms prefer working with a business entity.
• Your profit is approaching the level where an S-corp election could save tax.
• You plan to bring in partners or investors.

#Switching from sole proprietor to LLC

1. Form the LLC (steps above) and get an EIN.
2. Open a new business bank account; move business income and expenses there.
3. Update contracts, invoices, website and payment platforms with the LLC name.
4. Transfer business assets (equipment, domain names) to the LLC.
5. Update licences and permits.
6. Keep filing Schedule C (single-member, default) — or file Form 2553 if electing S-corp.

#Frequently asked questions

Does an LLC save on taxes?

Not by default — a single-member LLC is taxed like a sole proprietorship. Savings come from electing S-corp status once profits are high enough.

Is an LLC worth it for a small side business?

It depends on your risk and state costs. In states with low fees, many people form one for protection. In California, the $800 yearly tax makes it a bigger decision.

Can I be a sole proprietor without registering?

Yes, in most places you're automatically a sole proprietor when you start doing business. You may still need a DBA and local licences.

Does an LLC protect me from everything?

No. You're still personally liable for your own negligence, personal guarantees, and if you mix personal and business finances.

What is the cheapest state to form an LLC?

Formation fees are lowest in states like Kentucky and Montana, but you generally should form in the state where you operate.

Do I need a lawyer to form an LLC?

No. Most people file online themselves. A lawyer or CPA is useful for multi-member agreements or S-corp planning.

Do I need a separate bank account for an LLC?

Yes. Mixing personal and business money is the most common way owners lose liability protection.

#Sources

• U.S. Small Business Administration — Choose a business structure
• IRS — Single member limited liability companies
• IRS — S corporations
• How to Start an LLC — LLC annual fees by state (2026)
• FinCEN — Beneficial ownership information reporting