Since the pandemic has changed many of our work lives, I’ve talked with a number of people who are starting new businesses. Some started working from home and now have more time to work on that “side hustle,” some are recently unemployed and providing freelance or “gig” services, and still others have online or other business ideas that have come about because of the coronavirus. Whatever their reason, I tell them all the same thing–first make sure you start your business with a sound structure.
If you work for yourself, you may want to structure what you do for legal and tax purposes into an official business. Your two main choices are to create a sole proprietorship or to incorporate as a Limited Liability Company (LLC). There are many formation and tax complexities to the decision but for this blog, let’s focus on the main advantages and liability distinctions between the two.
Why become a sole proprietorship?
A sole proprietorship is appropriate if you’re planning for a one-person business. As the name implies, if there is more than one owner, your business can’t be a sole proprietorship.
- File any necessary legal documents, including for the business name, and any local licenses required by the town, city, or state where the business is located.
- If you plan to sell taxable products or services, you’ll need to register with your state’s taxing authority.
- You may have to obtain licenses, permits, zoning clearances, or other permissions from your local government.
- Obtain an EIN (employer identification number), if necessary.
Here’s where we get to the primary disadvantage of sole proprietorships.
- Your personal finances and those of your business are the same.
- You are personally liable for any debts or obligations of the business.
- Lawsuits or creditors can access your personal accounts, assets, or property if your business can’t pay its bills.
You cannot file bankruptcy for your business without filing personal bankruptcy.
Choosing to incorporate has advantages, and but also additional costs. An LLC combines elements of a partnership, sole proprietorship, and a corporation to ensure that the owners of the company are not personally liable for their company’s debts or liabilities.
- Choose a legal name and reserve it with your Secretary of State.
- File a certificate of formation (this document has different names in different states) and pay filing fees to set up the entity.
- Apply for a business license and other certificates specific to your industry.
- File Form SS-4 or obtain an Employer Identification Number (EIN).
- Apply for any other ID numbers required by state and local government agencies.
- By structuring a new business as an LLC, that business starts as its own separate and legal entity.
- An LLC separates your personal assets from being targeted in lawsuits or by creditors.
- You have liability protection against commercial debts, lawsuits, and other obligations. If you set up your LLC properly, do not co-mingle personal & business assets, and appropriately fund your LLC with working capital, you can’t be sued personally for commercial activities.
Several more considerations go into your decision, including the tax advantages and disadvantages between the two, as well as funding and organizational considerations. The bottom line is, I want your entrepreneurial venture to be both officially established as a business but also protected. Let’s look at your situation together, and have a conversation about the best direction for you.