Sole Proprietorship or LLC
Sole proprietorship’s and LLCs are the most common business structures. Of the two, a sole proprietorship is the most popular and easiest to create. But it does not provide the legal and tax advantages that an LLC does. In this article, we will go over the main differences between a sole proprietorship and an LLC. We will go over differences in three areas: creation, protection, and taxes. After having the facts, you will be able to decide which business structure is best for your situation: sole proprietorship or LLC.
Each type of business entity requires a different creation process. A sole proprietorship is very easy to create, you just simply start doing business. You do not need to file any forms to start up. However, you can register your business name with the Arizona Corporation Commission so no one else can use it. You will still need to follow any rules and licensing procedures regarding the services that you offer.
An LLC requires a little more effort to set up. First, you will need to file Articles of Organization with the Arizona Corporation Commission. After you receive approval, you will then need to publish a copy of your Articles in a local newspaper. You will also need to file for an Employer Identification Number and any other appropriate paperwork according to the tax status you desire. We will go over the different tax status’ available to LLCs under the Taxes subheading.
Sole proprietorship’s offer you no level of legal protection. This is because there is no distinction between business and business owner. Business creditors can go after your business assets as well as your home, car and other personal property. Your personal assets are also on the line if you are sued.
On the other hand, an LLC grants you entity protection because it separates the business from the business owner. Your liability is limited to what you have invested in the LLC. You are not personally liable for any business debts. This means that your home, car and personal property is safe. An LLC will afford you protection from lawsuits and creditors on a personal level.
As a sole proprietorship, the business income and losses are always listed on your personal tax return. You can deduct your business expenses against your gross income. Such expenses may include mileage for business travel, business meals, office equipment and home office expenses. You will have to pay self-employment tax on any income earned, in addition to your normal income taxation rate.
If you create an LLC you will have a few different choices. First, if you are a single member LLC you can choose to be treated as a disregarded entity. This means that your tax situation will be the same as if you were a sole proprietorship. Your second choice is to be a partnership for tax purposes. You can elect this status if your LLC has 2 members. You will report your annual business income on a Form 1065. To file your taxes, you and your partner will receive a K-1. You will use your K-1 to report your portion of the income on your personal return.
Your third choice is to classify yourself as an S-Corp. You will report all income and deductions on a Form 1120s. Under this classification, you must payroll yourself an ordinary and customary amount for your line of business. Any business income leftover will avoid payroll taxes. Finally, you can also choose to be a C-Corp. With this classification, your business will be taxed as a separate entity. The business will report it owns income and deductions. In this situation, payroll counts as a deduction and taxes on additional income are paid by the business at corporate rates.
Business taxation is very complex. This is just a general overview, you should meet with a qualified tax preparer and have them go over your situation before picking a tax designation.
Whether you decide to operate your business as a sole proprietorship or LLC, it is important that you educate yourself on the basics of each entity. It is our hope that this article helps to make your choice easier.
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