Question

Individuals who are sole proprietors or who have formed single member LLCs report business income on Schedule C of Form 1040.

Please use the IRS website as your source of research and provide us with information as to why sole proprietors would benefit from organizing their businesses as single member LLCs.

Please let us know if there are any disadvantages to this form of business organization.

Answer 1

Benefits sole proprietor would derive from organizing business as a single member LLCs.

The benefits are :

Limited Liability

The main benefit in organizing your business as an LLC instead of a sole proprietorship is that LLCs, as their name suggests, offer limited liability. Members of an LLC typically are not personally liable for the debts of the business. If the LLC faces a lawsuit, goes bankrupt, or cannot pay its debts, the members' personal funds and property are not at risk.

Taxation

LLCs enjoy "pass-through" taxation, which means that instead of the business entity paying federal income tax at the corporate level, profits pass through to the members, who report the income on their personal tax returns.

In a single-member LLC, the owner pays taxes on her personal income tax return as if she were a sole proprietor, which can also save time and money in tax preparations as opposed to having to file corporate taxes. Because of this tax setup, an SMLLC gets the benefits of a corporation, particularly limited liability, but does not have to pay corporate taxes.

Options for Raising Capital and Transferring Ownership

The business structure of an LLC provides various opportunities to raise capital, including offering admission to additional LLC members. New members, of course, would also enjoy limited liability, which could be a major selling point in convincing them to invest in the business.

Moreover, if you want to transfer ownership of your company to someone else, the process is generally easier to do because you can sell an LLC whole and without any interruptions in business. A sole proprietorship's parts—licenses, permits, and other assets—must be sold separately.

More Professional Appearance

You may find that having a registered LLC simply offers a more professional appearance than operating solely under your name. This perception could make it easier to gain clients and garner their respect.

Disadvantages of this form of Business organization are :

Increased Startup and Operating Costs

To form an LLC, you must file the correct forms and fees with the appropriate state agency. In California, for example, you must file the articles of organization and a filing fee, as well as a statement of information and an additional filing fee, within 90 days of your LLC's registration. A California LLC is also subject to an annual franchise tax.

Starting a sole proprietorship, on the other hand, costs nothing and does not involve annual fees.

Increased Paperwork

Forming an LLC also requires more paperwork when compared to forming a sole proprietorship. As noted above, states require LLCs to file articles of organization and sometimes other documents. To start a sole proprietorship, you don't have to write anything down, even for your own records.

On top of that, in some jurisdictions, an LLC must file an annual report, and if you want to close your LLC, you must follow formalities to do so. On the other hand, states generally do not require any reporting from sole proprietorships and you can close up shop any time you like without filing any forms.

Potential False Sense of Security

Especially in states in which yearly reports are not required for LLCs, you must be careful that this informality doesn't lull you into getting too lazy about keeping business records. Should your business face a lawsuit and you do not have proper LLC documents, such as an operating agreement, in place, a court could choose to pierce the corporate veil, strip away limited liability, and hold you personally responsible for the company's debts and liabilities.

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