By Melissa Gold, Insureon Contributor
How you classify your business is a decision that could affect your exposure to risk and how you pay taxes. The differences can be subtle, but it’s important to know the benefits of sole proprietorship versus a limited liability company before you start your business.
What’s the difference between a sole proprietor and an LLC?
A sole proprietor is defined by the IRS as a person who owns an unincorporated business. Any person who does business but isn’t registered as a corporation, partnership, or limited liability company is a sole proprietor by default.
A sole proprietor is personally liable for any debt accrued by the business, including lawsuits and other business obligations. If a sole proprietor owes money from a lawsuit judgment or any other debt and the business assets are not enough to cover it, creditors could go after personal assets.
A person who owns a business alone can also file for LLC status. If an LLC owes money that it can’t pay, the owner’s personal assets are protected and creditors won’t be able to reach them.
Other key differences between a sole proprietorship and an LLC:
- Filing for your business classification. Filing for an LLC usually has a cost, which varies from $50 to about $500, depending on the state where you do business. The process only takes a few weeks in most cases; it’s simple paperwork, but filing and processing with the state will take some time. There’s no cost to becoming a sole proprietor. You need to manage your own tax withholding and insurance, but there’s no payment or government filing required to start a business.
- Credit and loans. If your business has overhead that you need to pay for with a line of credit or loan, an LLC will be more credible and less risky to a lender than a sole proprietorship. The LLC can sometimes offer an ownership interest in the business as collateral for money used to finance business growth or overhead. A sole proprietor cannot offer ownership of the business to another person or entity because it would no longer be a sole proprietorship.
- Ownership. A sole proprietorship is owned by one person by definition. If you have LLC status, you’re able to include additional owners that are people, corporations, other LLCs, partnerships, trusts, or estates.
- Ongoing business status. A sole proprietorship will typically cease to exist if the owner dies or sells the business. An LLC can continue with an operating agreement to protect the assets of the business.
Hiring employees as a sole proprietor or LLC
Whether you’re a sole proprietor or LLC, your workers’ compensation requirements will likely be the same if you hire an employee. Most states require any business with employees to carry workers’ compensation, and some states have specific requirements for whether coverage is required for the sole owner.
If you hire employees, it’s especially beneficial to file as an LLC for liability purposes. Workers’ compensation insurance would cover an employee’s workplace injury if one occurs. It wouldn’t provide protection for any other kind of liability from an employee’s negligence or accidental damage of property.
General liability insurance for your small business
Whether you’re a sole proprietor or the owner of an LLC, general liability insurance is crucial. General liability insurance covers company assets and is often required to sign contracts. If you are a sole proprietor, liability policies can also help shield your personal assets if you are held liable for an injury or property damage.
General liability insurance can cover the legal fees associated with a lawsuit and provide general protection for property damage and injury of non-employees, product liability, and even advertising injury protection in the event of a lawsuit for slander, libel, or accidental copyright infringement.