- Posted by Donna Amos
- On November 5, 2014
- business structure
As a solopreneur, especially a first-timer, you may feel overwhelmed by legal vocabulary, tax structures, and licensing. It’s easy to get bogged down in the details, and what’s worse, there’s tons of misinformation out there.
In your research, you will have encountered several business structures, which all sound strangely alike. The good news is the choice is simpler than you think!
When you’re first starting out as a solopreneur, there are really only two options: a sole proprietorship or a limited liability company (LLC).
For this article, we’ll consider Mary Johnson, an enterprising young lady making and selling artisan cupcakes from her home.
A sole proprietorship is the simplest business structure, and is what most solopreneurs are whether they know it or not! Features of this structure are:
Easy to set up and run:
If Mary does business under her own name, for example, “Mary Johnson’s Cupcakes,” she already is a sole proprietor. While she won’t register a business entity with the state, she isn’t necessarily done. Since Mary is making and selling cupcakes and other food from her home, she might have to register for sales and other taxes, as well as specific licenses and permits.
Additionally, if Mary wanted to operate under another name, such as “Clever Cupcakes,” she may need to register a fictitious name with either the state or the county.
No name reservation:
Let’s say Mary does use Clever Cupcakes as her fictitious name. In many states, a fictitious name is not reserved, which means anyone wishing to form a business entity (such as an LLC or a corporation) can take it from her. In order to keep the name for her exclusive use, Mary would have to register “Clever Cupcakes, LLC” with the state.
With a sole proprietorship, taxation is simple. Mary would declare her business income next to her personal income in Schedule C of the annual Form 1040.
No limited liability protection:
The major disadvantage of sole proprietorship is no limited liability protection. If someone becomes ill from eating an undercooked cupcake, and sues Mary, all of Mary’s personal assets (her home, car, savings, and everything else) can be targeted and potentially seized.
Forming an LLC or other business entity grants the owner limited liability protection, which means in the event of a lawsuit, only the business’ assets can be targeted and seized.
Limited Liability Company (LLC)
Forming an LLC is a great way to obtain limited liability protection, while having the flexibility of a sole proprietorship. Here are the features of an LLC:
Easy to set up and run:
To form “Clever Cupcakes, LLC,” Mary needs to file a formation document with her state’s Corporations Division. There is a cost to form an LLC, and she will also need an operating agreement, and to obtain necessary business licenses and permits. However, these fees and activities are worth the benefits an LLC provides.
It is possible to be a single-member LLC, which means you are the only owner. If you want to add another owner later, that’s possible too.
Limited liability protection:
As its name suggests, a limited liability company protects the owner’s personal assets in the event of a lawsuit. This is the biggest advantage of forming any legal entity, and it almost always outweighs any costs involved.
This protection can be pierced if the entity is no longer in good standing with the state, meaning you haven’t complied with state requirements. Be sure to keep up with ongoing filings required to maintain your LLC!
If Mary has a single-member LLC, she would declare business income on her annual 1040, exactly as she would if she were a sole proprietor. LLCs also offer flexible taxation, so it is entirely possible Mary may elect to be taxed as a C-Corp or an S-Corp as her business grows.
Having the designator “LLC” at the end of your business name adds credibility to your business. It shows your customers that you’ve gone through the necessary steps to register with the state. Be sure to include it in your logo and as part of your marketing strategy! This might give your business an advantage over your amateurish competitors!
So what should Mary do?
In most cases, having the flexibility and liability protection of an LLC is more advantageous than being a sole proprietor. However, Mary should take into account her financial situation, her plan for growth, and whether her business would benefit from forming an LLC. Ultimately, the decision is hers!
Thank you James for great info.
Blogger and Community Outreach Manager at Harbor Compliance. Harbor Compliance helps entrepreneurs and business owners nationwide with their business registration and compliance filings. We are passionate about helping small business and nonprofit leaders start and run compliant organizations. James has personally done filings in all 50 United States and the District of Columbia.
Contact info: 717-431-9021, firstname.lastname@example.org