Disclaimer: We are not lawyers nor accountants. The following information is the result of our own experience and research. Before acting on any of the information below, we encourage you to contact your Secretary of State or county clerk for advice on the appropriate entity for your business needs, as well as an accountant for any tax-related matters.
When it comes to establishing a new business, the legal structure you choose could have a huge impact when it comes to taxes, legal liability and ultimately, your bottom line. This is especially true as the virtual business landscape continues to evolve.
Over the last year, one of the most common questions that we’ve received from aspiring paraplanners is whether or not they should start out as a Sole Proprietor or create an LLC. Rather than continue to delve into this topic on a one-on-one basis, we decided to expand it and share it on the blog.
Keep reading to see our thoughts on the pros and cons of both, a Sole Proprietorship and LLC — as well as the tax, legal and financial implications.
A Sole Proprietorship is the most common entity that new business owners create thanks to the relative ease of the set-up process. To begin, you simply start working.
No, really! Since you ARE the business, you can use your legal name as the official business name (and even add “virtual paraplanner” if you’re feeling fancy) and start seeking out clients.
If on the other hand, you want to name the business something other than your legal name, you’ll need to file DBA (doing business as) paperwork in the state/county you plan to do business in — which may cost a few hours of your time and no more than $100.
All considered, still relatively simple and inexpensive.
One word of caution, though. As the Sole Proprietor, for legal purposes, you and your business are one. What that means for you is your personal assets (car, home, etc.) are at risk if any lawsuits were to be brought against your company.
For that reason, if you choose to go the Sole Proprietor route it’s important that you have a signed agreement in place with every advisor that clearly expresses you are not liable for any mistakes in the client’s plans and that the advisor is responsible for reviewing all work before it reaches the client.
The Bottom Line: A Sole Proprietorship is a simple, low-cost way to legally start your business. However, if you choose this option be sure to protect yourself by having a contract in place that limits your personal liability in the event of legal action.
Limited Liability Company
In many ways, a Limited Liability Company (or LLC), is similar to a Sole Proprietorship in that you can operate it alone as a one-man or one-woman show, and (as a single-member LLC) your profits and losses flow through to your individual tax return.
However, unlike a Sole Proprietorship, an LLC can have partners and perhaps most importantly, your personal assets are protected in the event of a lawsuit.
When it comes to creating your entity, the process of establishing an LLC is a bit more cumbersome than that of a Sole Proprietor.
In most states, to set up an LLC a significant amount of paperwork is required, along with the filing of Articles of Organization with your Secretary of State and the payment of a filing fee. Over the years, the process has been simplified and many states will even let you complete this process online or by mail.
Another key difference between a Sole Proprietorship and an LLC is the cost.
While the price is significantly more expensive for setting up an LLC, the cost is minimal compared to the peace of mind that comes with knowing your personal assets are safe from a lawsuit.
The Bottom Line: The primary benefit of establishing an LLC over a sole proprietorship is that the LLC shelters your personal assets from litigation. On the other hand, the costs associated with an LLC can be expensive depending on your state of filing and, in some cases, may require annual fees to maintain active status.
Here are a few additional factors to consider when deciding between a Sole Proprietorship or an LLC:
In addition to set-up and annual fees, LLCs are also subject to entity-specific state laws. Depending on the state you’re registered in, these laws may create additional requirements (such as annual statements and/or reporting) to maintain your LLC.
Sole Proprietorships, on the other hand, are not required to adhere to any type of state regulations.
Separation of Business and Personal Expenses
As a Sole Proprietor, you and your business are considered one as far as the law is concerned which means there is no restriction that prohibits the intermingling of business and personal funds. That said, it’s still a best practice to keep things separate for accounting purposes and to easily identify your deductible expenses come tax season.
With an LLC, it’s required that you separate business funds from your personal accounts. In fact, the laws around this rule are so stringent that violating them could result in losing your limited liability protection.
Tax Filing Requirements
If you choose to operate a sole proprietorship, the profit that you earn from your business will be counted as personal income for tax purposes. Conversely, an LLC may elect to be taxed as a corporation, a sole proprietorship or a partnership — depending on its number of members.
This flexibility in filing status is often the reason why many people believe that an LLC is a Sole Proprietorship. Of course, it’s not, but for tax purposes it may be taxed as one, depending on the circumstances.
Understanding the options available when establishing your business entity is a prudent lesson for every business owner. While there’s no one answer for how a virtual business should be established, hopefully by understanding the advantages, as well as the disadvantages of the two most popular options, you should be able to make the best decision for your business.
For more information on choosing the right corporate structure for your business, check out this quick summary from The Hartford on the pros and cons of each entity type — as well as a few other business resources to help you get started.