LLC v. Sole Proprietroship: Which Shall Prevail?

LLC v. Sole Proprietroship: Which Shall Prevail?

In our last blog post, “Does Your Sole Proprietorship Require a Federal Tax Id?” we briefly discussed the definition of a sole proprietorship. In this follow-up post, we describe more in depth and compare the benefits and disadvantages of a sole proprietorship to those of a limited liability company (LLC). When aiding clients in business formation, it is important to address the specific needs of each client in order to determine which form of business entity is a best fit.

Ownership

In a sole proprietorship, there is one individual titled as owner and the business name is the same as the owner’s name, unless the owner files for a fictitious business name. Furthermore, only an individual may be the owner of a sole proprietorships. LLCs, corporations or any other type of business, may not be titled as owner of any sole proprietorship. With this strict individual ownership, the profits of the sole proprietorship are listed on the personal tax returns of the business owner.

LLCs on the other hand, have no limit to the number of members/owners. There may be one member or several and membership is not limited to individuals. Corporations, other LLCs, or foreign entities may be LLC owners. LLCs provide more flexibility in the selection of business names as well.  The only requirement is that the name contain the correct abbreviation for a limited liability company (depending on the state), at the end of the business name.

Business Formation

A sole proprietorship is the easiest business to form. One must only participate in a business transaction to be considered a sole proprietorship. Such business entities are not required to be chartered by any state.

When creating an LLC, articles of organization or a certificate of formation must be filed in its state of operation. The associated fees with such filing must be paid and the information listed on such articles includes the number of managers or directors in the LLC and the purpose of the business.

Liability

While the owner of a sole proprietorship has unlimited power of the decision making in his or her business, and thus actions may be taken much more quickly than in an LLC, a sole proprietorship owner also carries the weight of his or her business debts and is personally liable for any occurrence concerning the business.

Limited Liability Companies might take longer to carry out decisions due to the possibility of numerous owners having to act together.  However, business liabilities and debts belong only to the separate business entity.  When properly set up, individual owner’s assets can be protected from business related claims. Thus, generally, creditors may not pursue any personal wealth of LLC members.

The Verdict

At the end of the day, there is no absolute answer to whether a sole proprietorship or an LLC prevails as the better business choice. Every business should be formed individually and based on its and its owners personal needs. Thus, determining the facts about your potential business and comparing them to the aspects of different business entities is the best method to determine which business formation better suits you.

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Does Your Sole Proprietorship Require a Federal Tax ID?

Business and Taxes go hand in hand!

Many of my new client initial contacts revolve around inquiries about trade secret, trademark or copyright protections.  While these are important new business issues to address, more often than not new business clients are so focused on the nuts and bolts of their new venture that they have not thought too much about whether and how to organize that business.  While corporate or limited liability entities are sometimes appropriate, the initial activities of many new businesses occur by an individual doing business as a sole proprietor under their own name or a fictitious business name.

One frequent question is whether or not a sole proprietorship requires a federal Employer Identification Number (EIN). Like many, the answer to this question is not a simple yes or no.

What is a Sole Proprietorship?

A sole proprietorship is a business run by a single owner. While it is possible to have more than one individual running the business, there can only be one person listed as the entity’s owner. The owner of the sole proprietorship is personally liable for any debt incurred by the business or lawsuits brought against the business. Despite this, running a sole proprietorship has its perks. For example, the owner of such a business has complete control over any and all decisions made concerning the business. Also, a sole proprietorship is not required to be chartered by any state and finally, while every business, regardless of the type of entity, is responsible for paying both state and federal taxes, not every sole proprietorship must obtain an EIN.  Only certain sole proprietorships must obtain this tax ID, if their business meets the requirements laid out by the IRS to do so.

Standard Requirements:

Any sole proprietorship falling under the following categories must obtain and file taxes under an EIN:

  • Sole Proprietorship with employees
  • Sole Proprietorship that withholds payroll income taxes
  • Sole Proprietorship that files federal tax returns on employment, excise, alcohol, tobacco, and or firearms
  • Sole Proprietorship involved in real estate, plan administration, farmers cooperatives and trusts, or holding Keogh plans

Whether required to obtain an EIN or not, every sole proprietor has the option of doing so.  Even if an EIN is not required, it may be preferred simply in order to separate the client’s business financial activity and tax reporting events from the owner’s personal social security number.

How to Apply for an EIN:

EIN’s are issued by the Internal Revenue Service.  The process is simple.  An individual can request up to five (5) Employer Identification Numbers a day from the IRS.  Individuals may request their EIN by mail, through fax, online or by telephone.  For a quick approval, obtaining an EIN by telephone or online is the best method. These two methods enable an individual to have their EIN approved immediately if no additional information is required.  If requesting an EIN by mail or fax, allow for at least 4 weeks before expecting an EIN issued for your company. EIN applications sent by fax or mail are processed on a first come first serve basis.

The following website contains a fast, secure online form to request a Federal Tax ID.  http://www.simplefilings.gov-tax.com/federal-ein/

Regardless of the method one chooses to use, obtaining an EIN is fairly simple and provides your business with a form of federal identification separate from the owners personal identification information.