Yes. An LLC status can provide you with legal protections and long-term tax benefits.
A sole proprietorship is the easiest type of business to form. But staying a sole proprietorship instead of forming a limited liability company (LLC) could mean you’re personally liable for any debt or legal trouble your business gets into later on.
You could prevent yourself from a flurry of financial and legal challenges by simply registering as an LLC. Although it takes more time and money, turning your sole proprietorship into an LLC is almost always worth it.
Before you decide to form an LLC or take any other legal action with your business, you should consult your tax advisor and attorney. You might not see why it’s important if you’re just starting out, but those protections become more important as you scale up.
The sooner you register your LLC, the better — because the more you scale up, the harder it is to make that transition.
What’s the difference between an LLC and a sole proprietorship?
A sole proprietorship is anyone who runs their own business without registering it with the state. It requires little to no formal setup — if you start selling something with the intent of making a profit, you’re automatically a sole proprietor.
An LLC is a legal entity that’s registered with the state. It has a formal registration process and more regulations you need to follow as a business owner.
Besides them having a formal registration process, there aren’t many differences between sole proprietorships and LLCs with one owner and no tax election. Both types of owners report their earnings on Schedule C as part of their individual tax return, Form 1040, and have to pay self-employment taxes.
However, when you do register as an LLC, you have more legal protections than you did before.
Advantages of becoming an LLC
An LLC and sole proprietorship are the same in a lot of ways, but an LLC can protect you in ways that a sole proprietorship can’t.
Here are some of the benefits of registering your business as an LLC:
- More legal protection: As an LLC, you’re legally separated from your business. So in the case of bankruptcy or lawsuits against your LLC, your personal assets are more likely to be protected if your LLC is set up correctly. You also aren’t personally liable for paying off debt that your business incurs, as long as you didn’t personally guarantee it.
- Tax advantages: Starting an LLC doesn’t have many immediate tax advantages. After all, you can qualify for many deductions and credits as a sole proprietor. The main tax advantage of an LLC is that it can be taxed in a few different ways. The most common are as a sole proprietorship, partnership and S corp. An S corp can especially offer you tax savings that a sole prop can’t, because you don’t have to pay self-employment tax on your distributions.
Disadvantages of becoming an LLC
Despite its advantages, becoming an LLC does require a bigger time and financial commitment. Here are some of the cons of registering your LLC, but they shouldn’t drive you away from the process:
- Bigger time commitment: On top of running your business, there’s a lot of record-keeping and paperwork your LLC has to go through during your first year. You have to file articles of organization and annual reports, find a registered agent, apply for an Employer Identification Number and more. This process can be both time-consuming and stressful if you’ve never done it before — but there are business registration services that make it much easier.
- Costs more money: The cost to register an LLC can range from $400 to over $3,000. It can cost even more, depending on your industry, size and states you operate in.
- Keeping your personal and business finances separate: Learning how to keep your finances separate is challenging for new business owners. You may have to open new bank accounts and learn how and when to use them, which can be confusing. However, this is a crucial thing to learn early on to stay legally protected and keep your finances organized.
When you should become an LLC
If you’re a sole proprietorship, you should become an LLC as soon as possible.
Things like being subject to lawsuits and debt might not seem like a big deal if your business is just starting out. But as your business grows, the greater your chances are of being subject to those.
It’s better to be prepared for those situations early. If you wait until a lawsuit hits you, it might be too late.
It also sets you up for tax savings later in the future. If you ever want to make an S corporation election in the future that saves you in self-employment taxes, you need an LLC to do that.
How to become an LLC
There are two main ways to register your LLC. You can do it entirely yourself or hire a business registration service to do it for you. The former costs less, but takes longer and can lead to mistakes. The latter costs more, but leaves you with more time to focus on the parts of your business you love and makes sure everything is done right.
Registering your business yourself
There are eight steps to starting a business. Registering your business yourself is best for people who have done it before and know the best practices. You may not want to register your first business yourself because you might not choose the best business structure for you or cover all your bases.
The main benefit of registering your business yourself is that you’ll save money. A business registration service can cost around $600 to $800 on average. If you were to do everything yourself, the bare minimum cost to register your business is $400.
Hiring a business registration service
A business registration service handles the entire process for you and can save you from stress. They can also save you hours of paperwork — but they might cost you more.
There are a few options for business registration services. There are automated services like LegalZoom and ZenBusiness, where you dictate much of the process. There are also services with real people like DiMercurio Advisors that will talk to you and find the best business structure for you.
The bottom line
Sole proprietorships are the easiest type of business to form. It’s a simple and inexpensive way to get your business up and running. But you should eventually turn it into an LLC.
An LLC can give you more tax flexibility than a sole proprietorship can — and offer more legal protections. Registering your LLC can be time-consuming and costs more than staying a sole proprietorship, but it’s an investment that’s worth it for many business owners.
Not sure if you should switch from a sole prop to an LLC? Schedule a free call with a DiMercurio Advisors team member to see if it’s right for you and gain peace of mind knowing that you and your business are protected.
