Sole Proprietor vs LLC: Which Is Right for Your Small Business?

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Sole proprietor vs LLC is one of the first choices you face when you start a business. Both are simple, both let profits flow to your personal tax return, and both work well for one-person businesses. The big differences are personal liability protection, paperwork, cost and how much flexibility you have on taxes later.

This guide explains each option in plain English, walks through an illustrative example for a freelance photographer, and gives a side-by-side table so you can decide which fits your business today.

The Short Answer

• A sole proprietorship is the default. If you start selling goods or services on your own and don’t file anything with your state, you’re a sole proprietor. There’s no separate legal entity, so you and the business are the same in the eyes of the law.
• An LLC (limited liability company) is a separate legal entity you create by filing with your state. It can shield your personal assets from most business debts and lawsuits, and by default it’s taxed much like a sole proprietorship.

If your business has real risk, such as customers on site, employees, contracts, or physical products, an LLC is usually worth the small cost. If you’re testing an idea with little risk, a sole proprietorship is a fine place to start.

What Is a Sole Proprietorship?

A sole proprietorship is a business owned and run by one person with no legal separation between owner and business. You don’t need to file formation paperwork with the state, although you may still need a local business license, a sales tax permit, or a DBA (“doing business as”) filing if you use a name other than your own.

Profit and loss go straight onto your personal return using Schedule C of Form 1040. You can use your Social Security number, though getting a free EIN from the IRS keeps your SSN off client forms.

The catch is liability. Because you and the business are one and the same, your personal savings, car and sometimes your home can be at risk if the business is sued or can’t pay its debts.

What Is an LLC?

An LLC is a business entity formed under state law by filing articles of organization (some states call it a certificate of formation). It has its own legal existence, so the business, not you personally, is generally responsible for its debts and legal obligations.

LLCs are flexible on taxes. By default, the IRS treats a single-member LLC as a “disregarded entity,” so it’s taxed just like a sole proprietorship on Schedule C. A multi-member LLC is taxed as a partnership by default. An LLC can also elect to be taxed as an S corporation or a C corporation.

Side-by-Side Comparison

	Sole proprietorship	LLC
How it’s created	Automatically, by doing business	Filing articles of organization with the state
Personal liability	Owner is personally liable for business debts	Owner’s personal assets generally protected
Default federal tax	Schedule C on your personal return	Schedule C (one owner) or partnership return (two or more)
Self-employment tax	15.3% on net earnings	15.3% by default; S-corp election can reduce it
Formation cost	Usually $0, plus any local license or DBA	State fee of roughly $35 to $500
Ongoing state fees	Usually none	Annual or biennial report fees in most states
Paperwork	Minimal	Moderate: operating agreement, annual reports, separate bank account
Credibility with clients and banks	Lower	Higher

Liability Protection: The Biggest Difference

The main reason people form an LLC is to separate business risk from personal assets. If a client sues the business or the business can’t repay a supplier, creditors can generally go after only what the LLC owns, not your personal bank account or home.

That protection has limits. You’re still personally responsible for your own negligence, and banks often ask small business owners to personally guarantee loans. Courts can also “pierce the veil” and hold you personally liable if you mix business and personal money or ignore basic formalities. To keep the shield strong:

• Open a separate business bank account and use it only for the business.
• Sign contracts in the LLC’s name, not your own.
• Keep a written operating agreement, even if you’re the only member.
• File your state’s annual report on time.

Liability insurance still matters with an LLC. The entity protects your personal assets from business debts; insurance pays the claim.

How Taxes Work for Each

Pass-Through Taxation

Both a sole proprietorship and a default LLC are pass-through businesses. The business doesn’t pay federal income tax itself. Instead, the profit “passes through” to your personal return, and you pay income tax on it at your own rates. Both may also qualify for the qualified business income (QBI) deduction, subject to income limits.

Self-Employment Tax

As a sole proprietor or default LLC owner, you pay self-employment tax on your net earnings. For 2026 the rate is 15.3%: 12.4% for Social Security on the first $184,500 of combined earnings, plus 2.9% for Medicare on all of it. An extra 0.9% Medicare tax applies above $200,000 for single filers ($250,000 for married couples filing jointly). You can deduct half of your self-employment tax when figuring your income tax.

This is the same whether you’re a sole proprietor or a single-member LLC. Forming an LLC on its own doesn’t lower your taxes.

The S-Corp Election

An LLC (and a corporation) can file Form 2553 with the IRS to be taxed as an S corporation. You then pay yourself a reasonable salary through payroll, which is subject to payroll taxes, and take the rest of the profit as distributions, which are not subject to self-employment tax.

The savings can be real once profit is high enough, but so are the costs: payroll, a separate business tax return (Form 1120-S), and often higher accounting fees. Many owners don’t consider it until net profit is comfortably above a reasonable salary for their work. A sole proprietorship can’t make this election without first forming an entity. For more on paying yourself, see owner’s draw vs salary.

Worked Example: A Freelance Photographer

The numbers below are illustrative and simplified.

Maya runs a photography business with $60,000 of net profit for the year.

• As a sole proprietor: her self-employment tax is roughly $60,000 × 92.35% × 15.3% ≈ $8,477. She pays income tax on the profit on her personal return. If a wedding client sues over a damaged venue, her personal savings could be exposed.
• As a single-member LLC (default tax): her self-employment tax is the same, about $8,477. She pays a one-time state filing fee and any annual report fee, but her personal assets are generally shielded from business claims.
• As an LLC taxed as an S corp: say she pays herself a reasonable $40,000 salary. Payroll taxes on that salary are about $6,120 (15.3% split between her and the business). The other $20,000 comes out as a distribution without self-employment tax. That’s roughly $2,350 less in Social Security and Medicare tax, before subtracting payroll service and extra tax prep costs, which can eat a good part of it at this profit level.

The takeaway: the LLC buys liability protection, not tax savings. The S-corp election is where tax savings can come in, and only once profit is high enough to cover the extra cost. Tracking your numbers clearly helps here; see small business financial management and revenue vs income vs profit.

How Much Does an LLC Cost?

State filing fees for a new LLC range from about $35 in Montana to $500 in Massachusetts, with most states between $50 and $200. Many states also charge an annual or biennial report fee. A few charge much more: California has an $800 annual LLC tax, and Massachusetts charges $500 a year for its annual report.

Other possible costs include a registered agent (free if you serve as your own in most states), a name reservation, and any publication requirement in states such as New York. You can file directly on your state’s business filing website without paying a formation service.

A sole proprietorship usually costs nothing to set up beyond a local business license or DBA filing.

When a Sole Proprietorship Makes Sense

• You’re testing a side business with low risk and little income.
• You work alone, without employees, inventory or customers on your premises.
• You’d rather avoid state fees and paperwork for now.
• You live in a state where LLC fees are high relative to your expected profit.

When an LLC Makes Sense

• Your work carries real liability risk, like physical services, products, or client property.
• You sign leases, contracts or take on business debt.
• You want to look more established to clients, lenders and vendors.
• You plan to add a partner or may want the S-corp election as profit grows.

Many owners start as sole proprietors and form an LLC once the business proves itself. Switching later is simple: form the LLC, get a new EIN if needed, open a new bank account and move your contracts over. If you’re still choosing what to start, browse these business ideas.

How to Form an LLC in 5 Steps

1. Choose a name that’s available in your state and includes “LLC” or a similar ending.
2. Name a registered agent with an address in the state.
3. File articles of organization with your secretary of state and pay the fee.
4. Write an operating agreement that spells out ownership and how decisions are made.
5. Get a free EIN from the IRS, open a business bank account, and check for local licenses and permits.

Rules, fees and filing steps vary by state, so check your state’s official business filing site before you file.

This article is general information for US businesses, not legal or tax advice. Talk to a qualified attorney or tax professional about your situation.

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