Sole Proprietorship vs. LLC: Which Is Right for Your Business?

Published Wednesday 17 September 2025

Table of contents

• What's the difference between a sole proprietor and an LLC?
• Sole proprietorship pros and cons
• LLC pros and cons
• Sole proprietor vs. LLC: 4 key points
• When businesses typically set up as an LLC
• LLC or sole proprietorship – which should you choose?
• Making the right choice for your business
• FAQs about sole proprietor vs. LLCs

Key takeaways

• Evaluate your personal liability exposure before choosing a business structure, as sole proprietors face unlimited personal liability where creditors can seize personal assets like homes and savings, while LLCs provide legal protection by separating personal and business assets.
• Consider forming an LLC when you take on business loans, hire employees, expand operations that increase lawsuit potential, or accumulate valuable personal assets you want to protect from business risks.
• Recognize that both structures have identical tax obligations by default, with single-member LLCs taxed exactly like sole proprietorships unless you elect corporate tax status, making liability protection the primary differentiator rather than tax burden.
• Plan for the administrative requirements of each structure, understanding that sole proprietorships require no formation paperwork or ongoing compliance, while LLCs need state filing fees ($50-$500), annual reports in some states, and strict separation of business and personal finances to maintain liability protection.

What's the difference between a sole proprietor and an LLC?

Sole proprietorships are the simplest business structure where you operate without forming a separate legal entity. LLCs (Limited Liability Companies) are formal business structures that create legal separation between you and your business, providing personal asset protection.

The key difference: sole proprietors have unlimited personal liability, while LLC owners get legal protection from business debts and lawsuits.

What is a sole proprietorship?

A sole proprietorship is the default business structure for any single-owner business. You don't file formation paperwork or pay setup fees. However, there's no legal separation between you and your business. This means your personal assets are at risk if your business faces lawsuits or debts.

Learn more about sole proprietorships.

What is an LLC?

An LLC creates legal separation between you and your business, protecting your personal assets. To form an LLC, you must:

• File formation documents with your state
• Pay filing fees (typically $50-$500)
• Meet ongoing requirements like annual reports or fees in some states

Learn more about LLCs.

Sole proprietorship pros and cons

Deciding on a business structure involves weighing the benefits and drawbacks. Here's a look at the pros and cons of operating as a sole proprietor.

Pros of a sole proprietorship

• Easy and inexpensive to form: You don't need to file any special paperwork to get started. If you're doing business as yourself, you're already a sole proprietor.
• Complete control: As the sole owner, you make all the decisions without needing to consult partners or a board.
• Simple tax filing: You report business income and expenses on your personal tax return using a Schedule C, and according to the IRS, you must file if your net earnings from self-employment are $400 or more.

Cons of a sole proprietorship

• Unlimited personal liability: There's no legal separation between you and your business. Your personal assets could be at risk if the business faces debts or lawsuits.
• Difficulty raising capital: Banks and investors may be less willing to lend money to a sole proprietorship compared to a formal legal entity like an LLC.
• Perceived as less professional: Some clients or partners may view an LLC or corporation as a more established and credible business.

LLC pros and cons

An LLC offers more formal protections, but it also comes with additional responsibilities. Consider these points before making your decision.

Pros of an LLC

• Limited liability protection: This is the main advantage. It separates your personal assets from your business debts and legal liabilities.
• Tax flexibility: An LLC can choose how it's taxed. By default, it's taxed like a sole proprietorship (or partnership), but it can elect to be taxed as an S corp or C corp if that's more beneficial.
• Enhanced credibility: Having 'LLC' after your business name can boost your credibility with customers, suppliers, and lenders.

Cons of an LLC

• More complex and costly to set up: You'll need to file articles of organization with the state and pay filing fees, though a government report notes that states are not verifying the identities of company officials. You may also have ongoing fees and reporting requirements.
• More administrative work: LLCs require more formal record-keeping and compliance than sole proprietorships, such as holding regular meetings or filing annual reports.
• Separate records required: You must keep your business and personal finances completely separate to maintain liability protection, which requires careful bookkeeping.

When businesses typically set up as an LLC

Businesses typically choose LLC structure when they need liability protection, multiple owners, or tax flexibility. The three most common reasons:

• Personal asset protection: Shield your home, savings, and personal property from business lawsuits and debts
• Multiple ownership capability: Easily add partners or investors without complex partnership agreements
• Tax election flexibility: Choose to be taxed as sole proprietorship, partnership, S-corp, or C-corp based on your needs

LLC or sole proprietorship – which should you choose?

Most businesses start as sole proprietorships because it's the fastest, easiest way to begin operations. However, this simplicity may not serve you as your business grows.

Consider switching to LLC when you:

• Take on business loans or seek investors
• Hire employees who could create liability risks
• Expand operations that increase lawsuit potential
• Accumulate valuable personal assets you want to protect

Review your business structure annually to ensure it still meets your needs.

Get a professional to help you through the decision. An accountant, especially a CPA, can provide the analysis and advice you'll need.

Making the right choice for your business with Xero

Choosing between a sole proprietorship and an LLC depends on your long-term goals, your tolerance for risk, and how you plan to grow. A sole proprietorship is a great starting point, but an LLC offers crucial protection as your business expands.

No matter which structure you choose, clear and simple bookkeeping is key to your success. Xero provides the tools to manage your finances with confidence, helping you track income, manage expenses, and get a real-time view of your cash flow. This lets you focus on running your business, not just your books.

Ready to simplify your business finances? Try Xero for free today.

FAQs on sole proprietor vs. LLCs

Here are answers to common follow-up questions about choosing between sole proprietorship and LLC structures.

Can a sole proprietorship become an LLC?

A sole proprietor can create an LLC and move their business activities into that new structure. The business they do may stay largely the same but it is now a different entity. They'll need to update contracts and move to new bank accounts.

Depending on the state and industry, they may need new licenses and a new employer identification number (EIN), as the IRS requires an LLC to use its own EIN for the payment of employment taxes.

Can you convert an LLC into a sole proprietorship?

No. If you want to run your business as a sole proprietorship you'll need to close the LLC and then start from scratch, much like a sole proprietor becoming an LLC.

Can a single-owner business be an LLC?

Yes, you can form a single-member LLC. The process is the same as for forming a multi-member LLC.

Who pays more taxes, LLC or sole proprietor?

Neither structure inherently pays more in taxes. A single-member LLC is taxed just like a sole proprietorship by default, with profits and losses passed through to the owner's personal tax return.

An LLC only pays different taxes if it elects to be taxed as a corporation, which can sometimes lower the overall tax burden for high-earning businesses.

What is the biggest disadvantage to a sole proprietor?

The biggest disadvantage is unlimited personal liability. Because there is no legal distinction between the owner and the business, your personal assets—like your home, car, or savings—could be used to pay off business debts or legal claims.