Sole Proprietor vs LLC vs Corporation

The first question that usually comes up when starting a business is undoubtedly going to be which entity to use for your business.  As a business owner myself, I know it can be difficult to structure a business to make it as easy as possible while at the same time making it as profitable as possible.

The three most common types of structures for a small business are the sole proprietor, LLC, and corporation.  These are by no means the only options for business structure; there are many more options out there (e.g., general partnerships, limited partnerships, limited liability partnerships, cooperatives, non-profit corporations, etc.).  But they are not nearly as common or popular as the sole proprietor, LLC and corporation. So I’m not going to talk about them here! 🙂

Sole Proprietor vs LLC vs Corporation: The Sole Proprietor

If you are operating as a sole proprietor, this means that you have not really formed any legal structure of a business entity.  If you are just an individual making income from providing services or selling products and you have not registered anything with your state, then you are already operating as a sole proprietor.  If you are operating under a trade name (e.g., if I am operating a lawn mowing service under the name “Aiden’s Lawn Mowing Service,” that would be the trade name), then you should file a Statement of Trade Name with the Secretary of State in order to register the fact that you are operating under that trade name.  However, just because you file your trade name does not mean that you are an LLC or any kind of entity; you are still just a sole proprietor.

As far as taxes go, as a sole proprietor all of the income to the business is taxed as personal income to the business owner.

The pro of being a sole proprietor is that it is very easy to start; you just start a business and you become a sole proprietor.  One of the biggest cons for a sole proprietor is that there is absolutely no liability protection whatsoever for the business owner.  So if the business gets sued, it is, in essence, the individual business owner being sued and all of the business owner’s assets are subject to liability for any liabilities of the business.  So, a sole proprietor might be good for businesses that are not very high risk with liability or if, because of the industry, it is very unlikely that you will be sued.  However, I rarely recommend sole proprietorships simply because of the lack of liability protection and also because the fact that LLCs are, generally speaking, pretty easy to form.

Sole Proprietor vs LLC vs Corporation: The Limited Liability Corporation (LLC)

The LLC is the most popular entity formation and that is because (in Colorado, at least) an LLC is inexpensive and relatively simple to start and run.  To form an LLC, all you have to do is file Articles of Organization with the Secretary of State (or whatever agency operates business organizations in your state) and boom! you’ve got yourself an LLC. Of course, there are other things you need to do to make sure your LLC is going to protect you personally and to avoid piercing the corporate veil.

Similar to a sole proprietor, all of the income to the business is taxed as if it were personal income to the business owner.

Finally, the biggest difference between an LLC and sole proprietor is that an LLC does give you that liability protection.  So, if there is a lawsuit, or if the LLC is subject to some liability, then you as the business owner should be personally protected and your personal assets would most likely be safe from those liabilities.

Sole Proprietor vs LLC vs Corporation: The Corporation

When I say “corporation” in this context, I am referring to a C-Corporation specifically. (I’m going to touch on the S-Corporation in just a minute.) The corporation is a little bit more complicated and expensive to set up, but there are some instances where it would be useful to have a corporation.  First, it’s important to know that there are three groups of players in a corporation: Shareholders, Board of Directors, and Officers.  Shareholders are basically the owners; they own shares of the corporation.  The Board of Directors is responsible for making decisions about the operation of the corporation.  And the Officers are generally those that are actually participating in the business and managing the business and all of its activities.

Despite these various players, a small business can still form as a corporation and the Shareholder, Board of Directors, and Officers can all be one person.  In other words, one person can hold multiple positions within the corporation.  So, it is still possible to have a corporation as a small business and solo business owner.

To create a corporation, you will need to file Articles of Incorporation with the Secretary of State.  You will also need to write Bylaws, which are essentially the same as an Operating Agreement, but with regards to a corporation.   The Bylaws say how the corporation is going to be run and managed and operated.  If there are going to be multiple shareholders, then you will probably also want to have a Shareholder Agreement.

One of the biggest drawbacks of a corporation is that corporations are subject to double taxation.  When money comes into the business it is taxed at the corporate rate as income to the corporation, then when money is distributed to the shareholders, it is taxed again as dividends to the shareholders.

Finally, just like an LLC, the corporation provides liability protection to the Shareholders, the Board of Directors, and the Officers in most instances.  So if there is a lawsuit over the corporation or if the corporation has debts or liabilities, the Shareholders, Board of Directors, and Officers are most likely going to be protected personally from those liabilities.

A brief note on the S-Corporation

You can also elect to have your business taxed as an S-Corporation.  An S-Corporation is not an entity itself; it is merely a tax election that your business entity can make.  So you can be an LLC and be taxed as an S-Corporation or your corporation can elect to be taxed as an S-Corporation thereby avoiding the double taxation that comes with a C-Corporation.  By doing that, you can potentially save quite a bit of money on your tax liability.  I discuss the S-Corporation in more detail here.

In Conclusion…

For a vast majority of small businesses and startups, the LLC is going to be the best and most appropriate choice.  It is easy and usually inexpensive to get started.  Depending on the state you’re in, it’s pretty easy to run and maintain the LLC.   In Colorado, there aren’t too many requirements of what an LLC has to do on an annual or semi-annual basis.  And you will still get that liability protection that you otherwise would not have with a sole proprietorship.  As far as maximizing profits goes, if your business is at the point where it might be wise to elect to be taxed as an S-Corporation, then you can do that and save a lot of money on your taxes.

It is a good great idea to consult with an attorney to discuss sole proprietor vs LLC vs corporation and which is best for your business. Denver, Colorado business attorney Aiden H. Kramer with The Law Office of Aiden H. Kramer, LLC can help you set your small business up for success. Contact Aiden at (720) 379-3425 or [email protected] to get started.