LLC vs Sole Proprietorship: Differences, Taxes, Costs and Which to Choose

The choice between an LLC and a sole proprietorship often gets real when a bigger client sends a contract with a long liability clause. Until now you've worked alone and sent invoices under your own name. The choice decides what you pay the state every year and what you could lose if a job goes wrong.

If you do business alone and haven't registered a company, you already run a sole proprietorship. In law, you and the business are the same person. An LLC (limited liability company) is a separate business registered with a state. It can keep your personal assets apart from business debts and lawsuits, though that protection has limits.

Many people expect an LLC to lower their taxes. By default it doesn't change federal income tax at all, because a one-owner LLC is treated like a sole proprietorship. So the choice mostly comes down to:

• liability
• cost
• paperwork

A sole proprietorship is the cheapest way to start. An LLC suits owners who want that protection and a registered company. So we'll follow your business from where it is now to the point where the question gets real. Along the way you'll see the one tax option only an LLC can use.

LLC vs sole proprietorship side by side

Before you change anything, it helps to see the gap between where you are and where an LLC would put you.

The SBA says a sole proprietor can use an SSN, including for a business bank account.

The business you already have: a sole proprietorship

You may never have chosen this structure, but you're in it. The IRS describes a sole proprietor as "someone who owns an unincorporated business by themselves". According to the SBA, you're "automatically considered to be a sole proprietorship" if you do business without registering another type of company. So many freelancers are sole proprietors without having filed anything.

There's no formation filing with the Secretary of State. If you work under a name other than your own legal name, the SBA says you may need to register a trade name. It's also called a DBA ("doing business as"). Depending on local rules, you register it with one of these:

1. the state
2. the county
3. the city

The SBA also says a sole proprietor can use an SSN instead of an EIN. That includes opening a business bank account.

The main drawback is the one that bigger contract made you think about. Your personal and business assets and liabilities aren't separated. If the business owes money or loses a lawsuit, the debt is yours personally.

For taxes, you:

1. report business income on your personal Form 1040 with Schedule C
2. pay self-employment tax on Schedule SE
3. usually make estimated payments during the year with Form 1040-ES

The step you're considering: forming an LLC

An LLC is the next step up. Unlike a sole proprietorship, it takes a filing with the state.

The IRS calls an LLC "a business structure allowed by state statute". Each state has its own LLC law. That's why fees and yearly rules differ from one state to the next.

You form an LLC through the state's business office, usually the Secretary of State. The SBA says you need a registered agent in the state before you file. That's a person or company that receives official mail for the LLC.

The formation document is usually called the Articles of Organization. Texas calls it the Certificate of Formation. The SBA adds that many states recommend an operating agreement, which sets out the LLC's internal rules.

An LLC can have one owner (a single-member or one-person LLC) or several. With two or more members, the IRS taxes it as a partnership by default. If you know India's "One Person Company", the closest US form for a single owner is the single-member LLC.

Why your accountant may say it's "still a sole proprietorship"

Under state law a single-member LLC is a separate business, so it isn't a sole proprietorship. But for federal income tax, the IRS treats a single-member LLC as "disregarded". Its income goes on Schedule C, exactly as a sole proprietor's would.

The IRS also says the LLC still counts as a separate entity for employment taxes and certain excise taxes. These two answers to the same question explain why the topic confuses so many owners.

The contract that made you ask: how much protection an LLC gives

Liability protection is the main reason most owners form an LLC. The SBA says an LLC generally keeps personal assets safe if the business goes bankrupt or is sued. A sole proprietor has no such separation, so business debts are personal debts.

The SBA also says "that protection has limits". The SBA page doesn't list those limits in detail. So the safest reading is that an LLC reduces your personal exposure without removing it.

Taxes for an LLC vs a sole proprietorship

Protection is where the two structures differ most. On federal tax, you'll find they start out almost the same.

The same federal tax by default

A single-member LLC owned by a person reports on Schedule C. For some kinds of income it uses Schedule E or F instead. The IRS says the owner pays self-employment tax on net earnings "as a sole proprietor would".

Self-employment tax covers Social Security and Medicare for people who work for themselves. The rate is 15.3%:

• 12.4% for Social Security
• 2.9% for Medicare

You file Schedule SE if net self-employment earnings are $400 or more. Half of the tax, the employer-equivalent part, is deductible for income tax.

The 12.4% Social Security part applies only up to the yearly wage base. The Social Security Administration lists it as $184,500 for 2026. Some IRS pages still show the 2024 figure of $168,600.

An extra 0.9% Medicare tax applies above these income levels:

• $200,000 for single filers
• $250,000 for married couples filing jointly
• $125,000 for married individuals filing separately

The full mechanics are in Self-Employment Tax: How It Works and How to Calculate It.

The QBI deduction

The qualified business income (QBI) deduction lets eligible owners deduct up to 20% of qualified business income. The IRS lists these among those who can claim it:

• sole proprietors
• partnerships
• S corporations

A default single-member LLC reports like a sole proprietor, so it's in the same position.

For tax years beginning after 2025, the IRS says the deduction is the greater of two amounts. One is the taxable-income limit. The other is a new "Minimum Deduction for Active QBI". The IRS page doesn't give the amount, so confirm the current figure with whoever prepares your return.

When profit grows: the S corp election

As profit grows, you may hear about the S corp election. An LLC can choose to be taxed as an S corporation by filing Form 2553. A sole proprietorship can't, because there's no separate entity to make the election.

Under an S corp election, you get a salary through payroll. Payroll taxes then apply to that salary instead of self-employment tax on the whole profit. That's why some owners consider it.

The election comes with conditions. The IRS says payments for an owner's work must be treated as wages "to the extent reasonable". Courts look at:

1. training
2. duties
3. time spent
4. what others earn for similar work

So labelling all pay as distributions to avoid employment tax is improper. And there are more rules:

1. The owner has to run payroll.
2. Form 2553 is due within 2 months and 15 days after the tax year starts (March 15 for a calendar year).
3. You can also file it at any time in the year before.
4. An S corp can have at most 100 shareholders and one class of stock.
5. Nonresident aliens can't be shareholders.

Websites often quote a profit level at which an S corp "pays off". But there's no official threshold, and the answer depends on your own figures. The comparison is covered in detail in LLC vs S Corp.

If someone warns you about double tax

A default single-member LLC is disregarded for income tax. So its profit is reported once, on your return through Schedule C. Double tax only becomes possible if the LLC chooses to be taxed as a corporation with Form 8832.

That election can start up to 75 days before you file the form or up to 12 months after. Once a classification changes, the IRS generally doesn't allow another change for 60 months. An election that takes effect on a new LLC's formation date doesn't count toward that limit.

A slow year with no profit

Some years are slow. Federal income tax may be zero in a year without profit, but state costs continue. In California, the $800 annual LLC tax is due every year until the LLC is cancelled. That includes years with no income.

California's first-year exemption applied only to tax years beginning from January 1, 2021 to before January 1, 2024. So older articles that call the first year free are out of date. In Wyoming the annual report fee is at least $60. The IRS also notes that at-risk and passive-loss rules may limit how much of a loss you can deduct.

The bill from the state: what an LLC costs where you form it

Tax is one cost. State fees are another, and this is where the two structures really part ways.

A sole proprietorship has no state formation fee. An LLC pays one, and some states charge every year as well. The table shows official 2026 figures for four states.

In California, the $800 tax goes on Form FTB 3522 and the Statement of Information is Form LLC-12. In New York, the $50 is for the Certificate of Publication. If it isn't filed within 120 days, the LLC's authority is suspended.

California also charges a separate LLC fee when California income goes over $250,000. The fee starts at $900 and reaches $11,790 for income of $5 million or more (Form FTB 3536). The LLC also files Form 568 every year. The details are in California LLC Taxes and the $800 Franchise Tax.

The SBA says registering a business costs "less than $300" in most cases. But the figures above show this varies. New York's newspaper publication adds a cost that the state page doesn't list. And California's $800 is a yearly tax, not a registration fee.

The yearly filings are a cost of their own. A sole proprietor has no state filings for the structure. An LLC has to keep up with its state's reports and taxes for as long as it exists. The rules by state are in LLC Annual Report: Requirements, Fees and Due Dates by State.

Payday: taking money out

Once client money comes in, you also need to know how to take it out.

A sole proprietor and the owner of a default single-member LLC don't run payroll for themselves. They take money out as owner's draws. They pay income tax and self-employment tax on the profit, however much they withdraw. An LLC taxed as an S corp is different. There you must get reasonable wages through payroll before taking other distributions.

When to switch from a sole proprietorship to an LLC

With the taxes and costs in view, the choice mostly depends on how much risk your business carries. There's no single correct answer, and this is general guidance, not legal advice.

A sole proprietorship often fits when:

• you're testing an idea or doing small side work
• the work carries little risk of lawsuits or large debts
• the lowest cost and least paperwork matter most

An LLC gets more attractive as the business takes on obligations and risk:

• you sign contracts with clients, suppliers or a landlord
• your work could cause damage or injury that leads to a claim
• you plan to hire employees
• you want business and personal money clearly separated
• profit has grown and you want the option of an S corp election later
• you plan to bring in a partner or other owners

In our work with clients, most owners from outside the US choose an LLC because it's simpler. They move to a corporation later as revenue grows.

If you run the business from outside the US

Most of this applies to every owner. But a few rules matter only when the owner is a foreign person.

A single-member LLC wholly owned by a foreign person counts as a reporting corporation. It files Form 5472 every year with a pro forma Form 1120. It goes by mail or fax, not electronically. The penalty for not filing on time is $25,000. Another $25,000 is added if the failure goes on 90 days after an IRS notice. The rules are explained in Form 5472 for Foreign-Owned US LLCs: Who Must File, Due Date and Penalties.

Nonresident aliens can't be S corp shareholders. So the S corp election is generally not available to a non-resident owner.

On the EIN, the IRS page on single-member LLCs gives two points. An LLC with no employees and no excise tax liability doesn't need one for income tax. But most new single-member LLCs will need to get one, and you may need an EIN for a bank account.

BOI reports: the warning in older guides

While you read up on LLCs, you'll likely run into warnings about BOI reports. That rule has changed for every US LLC, wherever the owner lives.

FinCEN issued a final rule on August 11, 2026 that makes the March 2025 exemptions permanent. It took effect on August 14, 2026. US companies, LLCs included, no longer file beneficial ownership information (BOI) reports.

The only remaining "reporting companies" are those formed in another country and registered to do business in a US state. Older guides that say every LLC must file are out of date for LLCs formed in the US.

The mistakes we see after the switch

Many of these mistakes come from expecting an LLC to do more than it does. Others come from forgetting its yearly costs. The common ones are:

• Forming an LLC in the belief that it lowers federal tax by itself.
• Mixing personal and business money in one account.
• Forgetting yearly state costs, such as California's $800, due even with no income.
• Missing New York's Certificate of Publication, which suspends the LLC's authority after 120 days.
• Working under a brand name as a sole proprietor without checking whether you need a DBA.
• Putting the LLC's EIN on a W-9. The IRS says a disregarded LLC owned by a person uses the owner's SSN or EIN.
• Choosing S corp status without a plan for payroll and a reasonable salary.

Doing it yourself or using a formation service

Several of those mistakes happen during setup, so it's worth deciding early who does the work. A sole proprietorship needs no formation work beyond a possible DBA and any local licenses.

An LLC involves more:

1. choosing a state
2. appointing a registered agent
3. filing the Articles of Organization
4. preparing an operating agreement
5. getting an EIN
6. the yearly reports and taxes after that

Some states add their own requirements, such as New York's publication.

Doing it yourself costs only the state fees. But it takes time to read each state's rules. Mistakes like choosing the wrong state or missing a deadline tend to cost more later.

A formation service handles the filings and tracks deadlines for a fee that varies by provider. Either way, you stay responsible for the yearly filings. So it helps to know what they are and when they're due.

We file the LLC registration for new owners as part of a US launch and set up the Google profile and listings. The yearly reports and taxes stay with you and your accountant.

What to do this month

Start with the risk your work carries and whether you sign contracts with others. If the risk is low and you're testing an idea, a sole proprietorship may be enough for now.

If you form an LLC, check your state's yearly costs before you file, not after. And if you live outside the US, put Form 5472 on your calendar from the first year. The yearly filings by state are in LLC Annual Report: Requirements, Fees and Due Dates by State.