LLC vs. Sole Proprietorship: How to Choose the Right Structure

When you start a business, one of the first decisions you’ll face is how to structure it. For most small business owners and freelancers, the choice comes down to two options: sole proprietorship or LLC (Limited Liability Company).

Both are simple to set up, both offer pass-through taxation, and both work for one-person businesses. But they differ in one critical area: liability protection. Here’s everything you need to know to make the right choice.

What Is a Sole Proprietorship?

A sole proprietorship is the simplest business structure. It’s not a separate legal entity — it’s just you doing business. There’s nothing to file, no state registration (beyond a business license), and no formation costs.

When you start freelancing, sell products online, or offer services without forming any other entity, you’re automatically operating as a sole proprietorship.

Key characteristics:

• No formation paperwork required
• You and the business are legally the same entity
• All business income is reported on your personal tax return (Schedule C)
• You are personally liable for all business debts and obligations
• You can hire employees but cannot bring on partners (that creates a general partnership)

What Is an LLC?

An LLC (Limited Liability Company) is a separate legal entity registered with your state. It creates a legal barrier between your personal assets and your business liabilities.

Key characteristics:

• Requires filing formation documents with the state (costs $35–$500)
• The business is a separate legal entity from its owner(s)
• Pass-through taxation by default, with the option to elect S-Corp or C-Corp treatment
• Personal assets are generally protected from business debts and lawsuits
• Can have one owner (single-member LLC) or multiple owners (multi-member LLC)

Side-by-Side Comparison

Factor	Sole Proprietorship	LLC
Formation cost	$0 (free)	$35–$500 (varies by state)
Formation paperwork	None	File Articles of Organization
Liability protection	None	Personal assets protected
Taxation	Personal tax return (Schedule C)	Same default, with more options
Annual maintenance	None (or minimal license fees)	$0–$800/year depending on state
Separate bank account	Optional (but recommended)	Strongly recommended
Operating agreement	N/A	Recommended (required in some states)
Credibility	Lower perceived credibility	Higher perceived credibility
Raising investment	Very difficult	Easier (investors prefer LLCs)

The Case for a Sole Proprietorship

A sole proprietorship makes sense in specific situations:

1. You’re Testing a Business Idea

If you’re not sure whether your side project will become a real business, there’s no point in paying state fees and filing paperwork for an LLC. Start as a sole proprietorship, validate the idea, and convert to an LLC later if it takes off.

2. You Have Very Low Risk

Some businesses have inherently low liability risk — for example, a freelance writer working from home with no employees and no physical products. If the worst-case scenario is a client dispute over a $2,000 invoice, the cost and effort of an LLC may not be justified.

3. You Want Zero Costs and Paperwork

A sole proprietorship costs nothing to create and requires no state filings beyond a basic business license. If you value absolute simplicity and minimal overhead, it’s the easiest path.

4. You’re Earning Very Little

If your business earns under $10,000–$15,000 per year, the $50–$500 in LLC formation fees plus any annual report costs may not be worth it yet. The liability protection isn’t valuable if there’s very little to protect.

The Case for an LLC

For most serious businesses, an LLC is the better choice. Here’s why:

1. Liability Protection (The Big One)

This is the primary reason LLCs exist. As a sole proprietor, you are personally liable for everything your business does. If your business is sued, your personal savings, home, car, and retirement accounts are all at risk.

With an LLC, your personal assets are generally protected. If the LLC is sued or can’t pay its debts, creditors can only go after the LLC’s assets — not yours.

Real scenarios where this matters:

• A customer is injured by your product
• A client sues you for a project gone wrong
• Your business takes on debt it can’t repay
• An employee causes harm while working for your business
• A delivery driver causes an accident while working for you

2. Tax Flexibility

Both sole proprietorships and single-member LLCs are taxed the same way by default — as “disregarded entities” where all income flows to your personal return.

But an LLC can elect different tax treatment:

• S-Corp election: If your LLC earns enough (typically over $50,000–$70,000 in profit), you can elect S-Corp taxation. This lets you pay yourself a “reasonable salary” and take the rest as distributions, potentially saving thousands on self-employment taxes (15.3%).
• C-Corp election: Rarely useful for small LLCs, but available if your situation warrants it.

A sole proprietorship cannot elect S-Corp or C-Corp treatment. To get those tax benefits as a sole proprietor, you’d need to form an LLC or corporation first.

3. Business Credibility

An LLC appears more professional and established to clients, vendors, and partners. Having “LLC” in your business name signals that you’re a legitimate, registered business entity.

This matters for:

• Landing larger clients who prefer working with registered entities
• Opening business bank accounts and credit lines
• Signing contracts and leases
• Working with government agencies

4. Easier to Grow

Sole proprietorships are limited to one owner by definition. If you want to bring on a partner, you’d need to dissolve the sole proprietorship and form a new entity.

An LLC can easily add new members by amending the operating agreement. This makes it much simpler to:

• Bring on a business partner
• Give equity to key employees
• Accept investment (investors almost never invest in sole proprietorships)

Cost Comparison: What You’ll Actually Pay

Let’s look at realistic five-year costs for each structure, using a few example states:

Sole proprietorship costs assume only a basic business license. Actual costs vary by city/county.

In most states, the difference is a few hundred dollars over five years — a small price for liability protection. California is the notable exception, where the $800/year franchise tax makes an LLC significantly more expensive.

When to Convert from Sole Proprietorship to LLC

If you started as a sole proprietor, here are signs it’s time to form an LLC:

1. You’re earning consistent revenue — Once you’re earning enough that the business feels “real” and ongoing, the liability protection is worth having.
2. You’re taking on risk — Signing contracts, working with clients’ sensitive data, selling physical products, or hiring contractors all increase liability exposure.
3. You want to build business credit — An LLC can establish its own credit profile, separate from your personal credit.
4. You’re ready for the S-Corp election — If profits exceed $50,000–$70,000, the S-Corp tax election (only available to LLCs and corporations) can save you significant money on self-employment taxes.
5. You want to bring on a partner — Sole proprietorships can’t have partners; LLCs can.

How to Convert a Sole Proprietorship to an LLC

The process is straightforward:

1. Choose your state — Usually your home state. See our state comparison tool for fees and requirements.
2. File formation documents — Submit your Articles of Organization (or Certificate of Formation) with your state.
3. Get a new EIN — If you were using your SSN for the sole proprietorship, get a new EIN from the IRS for the LLC.
4. Open a business bank account — In the LLC’s name, using the new EIN.
5. Update contracts and licenses — Transfer any existing contracts, licenses, and accounts to the LLC.
6. Create an operating agreement — Even for single-member LLCs, this document establishes that you’re operating the business properly.

Bottom Line: Which Should You Choose?

Choose a sole proprietorship if:

• You’re testing a business idea and not sure it will last
• Your business has very low risk and low revenue
• You want zero costs and zero paperwork
• You’re doing occasional freelance work on the side

Choose an LLC if:

• You’re running (or plan to run) a serious, ongoing business
• You want personal asset protection from business liabilities
• You earn enough to benefit from S-Corp tax treatment
• You want to build business credit or bring on partners
• You work with clients, handle products, or have employees

For most people reading this guide, an LLC is the right choice. The cost is modest (as low as $35 in Montana or $40 in Kentucky), the protection is real, and the tax flexibility becomes more valuable as your business grows.

Use our state-by-state comparison tool to find the exact costs and requirements for forming an LLC in your state.