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You may be wondering, if you start an online business… Should you be a sole proprietor or LLC?
It’s a good question.
And making the right choice has important implications for your online business.
Operating as a sole proprietor is the easiest…
Then again… When is the easiest approach the best approach?
On the positive side, as a sole proprietor, of course you are in full control of your destiny.
However, the same is true if you’re structured as an LLC (Limited Liability Company).
On the negative side, as a sole proprietor you are simply operating your business as an individual who has not registered with their state as a type of business entity, such as a corporation, partnership, or LLC.
You’re traveling light.
In other words… Your business is you.
Talk to your lawyer and accountant, but at a minimum your responsibilities a sole proprietor will include keeping track of business expenses and income separately from your personal expenditures. At the end of the year, you will report your business gain or loss on your personal tax return.
What could be easier?
The Risks of Being a Sole Proprietor
The sole proprietor structure costs nothing to form. It is the simplest and most popular form of business start up because it is so easy.
However, choosing a sole proprietor structure means you will not have the same legal and tax advantages that a single member LLC provides.
As a sole proprietor, you are not considered a separate legal entity.
Operating as a sole proprietor exposes your personal assets to business creditors, and/or lawsuits, as your business is simply an alter ego of yourself, rather than a separate legal entity.
For instance, if your business fails you can be personally liable for any debts or liabilities incurred by the business. If you are sued by a client or have a legal disagreement, you could be personally liable for any claims that occur.
Business Benefits of the Single Member LLC
A limited liability company, or LLC, is a common legal structure for small businesses in America.
If you are operating your business as an individual, you may form what is called a “single member LLC”.
By forming a single member LLC, you gain the same flexibility benefits, independence and control as a sole proprietorship, while gaining the protection of being treated as a separate legal entity.
As a single member LLC, you will most likely declare yourself as the “Managing Member” of the LLC.
The Managing Member of the LLC is in charge of the LLC.
When you conduct business, any clients you work with or companies you do work for will use the name of the LLC (i.e. “My Online Business LLC”), rather than your individual name.
The LLC structure provides you with personal asset protection, since creditors can only go after business assets held in the name of the LLC.
An LLC protects the owners from the debts of and any judgments against the business.
As mentioned above, a single member LLC is similar to a sole proprietorship from a tax standpoint.
An LLC is considered a “pass through entity”. You may have heard a bit about “pass through entities” with the new Trump tax plan.
In a single member LLC, as the Managing Member of the LLC, you are compensated in the form of distributions of profit, which are made at the discretion of the Managing Member (i.e. you).
Profits (or losses) are taxed at your own marginal tax bracket (the tax rate applicable to the next dollar of taxable income that you earn).
Conversely, if your business declares a loss, you claim the losses on your personal tax return.
Insurance for Single Member LLCs
Another benefit is insurance.
If you have clients in your business, in certain business deals your clients may request that you provide them with proof of insurance coverage. Or that you add them as “additional insured” or that you sign a “hold harmless” or indemnification agreement.
All of these are legal concepts that have real world implications. Again, talk with your attorney or accountant.
While LLCs are able to obtain higher levels of coverage, sole proprietors can sometimes find it difficult to obtain higher levels of insurance coverage (i.e. $5,000,000 of per incident general liability coverage instead of $1,000,000).
However, by forming and operating as an LLC, you have indicated a certain level of sophistication and thoughtfulness in your business approach.
As a result, higher levels of coverage are often no problem for an LLC.
Online Business Sole Proprietor or LLC?
But how do I form an LLC?
The process usually only takes a few weeks to complete and may cost as little as $300-$1,000.
While there is a small investment, the upfront cost is well worth it when compared to the thousands, or tens or even hundreds of thousands of dollars you could be liable for in the event of a lawsuit, baseless or otherwise.
As a sole proprietor you may be exposed to such circumstances.
If you are a single individual, and are serious about your online business, you may want to strongly consider selecting an LLC or other form of formal business organization.
Remember… Forming an LLC is not a “silver bullet”, though.
You need to act and operate like a business, following proper tax filings, registering with the state, paying proper taxes for employees you may have, if any.
That said, if you are serious about online business, all of this may be a worthwhile investment.
NOTE: I am not providing legal advice, and am not a CPA or attorney. As such, you should not consider anything in this article to be tax or legal advice. You should consult your personal attorney or CPA before you make any decisions on the structure of your business or changing that structure.