LLC or sole proprietorship: decide in five questions

A sole proprietorship is not a thing you form. It's the default name for one person doing business without an entity: your name, your Social Security number, your tax return, your liability. The SBA puts it plainly — your business assets and liabilities are not separate from your personal ones, and you can be held personally liable for the debts and obligations of the business.

An LLC is a container you pay a state to create. It holds the contracts, the bank account and the debts, so a claim against the business is a claim against what's inside the container rather than against your house. That is the difference. It is the only difference that matters, and almost everything else people believe about the choice — that an LLC saves tax, that it makes you look serious, that customers check — is either untrue or too small to pay for.

So the decision is a trade: a few hundred dollars a year, and a little paperwork, against the size of what you'd lose on a bad day. Below is a way of making it in about two minutes, and then the two things worth understanding properly before you do — what each structure actually protects, and why the tax bill is the same under both.

An LLC separates the business's debts from your personal assets — the SBA's version is that your vehicle, house and savings aren't at risk if the LLC faces bankruptcy or a lawsuit. That's real and it's the reason to file. But the protection has four holes in it, and every one of them is common enough that a founder who doesn't know about them is buying something narrower than they think.

And the thing that actually pays a claim is insurance, not a filing. A general liability policy costs a small business about $45 a month on average, with most annual premiums somewhere between roughly $250 and $3,000 depending on the trade. When a customer trips over your equipment, the insurer writes the cheque and defends the claim; the LLC only decides whose name is on the lawsuit after the cover runs out. Both are worth having, and if you can only do one this month, insure.

What a sole proprietorship protects is your time and your money right now: nothing to file, nothing to renew, no annual report to forget, and no state fee. That is a genuine advantage for a business that hasn't proved anyone will pay yet. It stops being an advantage the moment there's something to lose.

This is where most of the bad advice lives. A single-member LLC is, in the IRS's word, disregarded: for income tax it's treated as not separate from its owner. The profit goes on the same Schedule C, at the same rate, with the same deductions and the same quarterly estimated payments, as it would with no LLC at all. The IRS says the owner of a single-member LLC pays self-employment tax on net earnings in the same manner as a sole proprietorship. Same form, same number, same due date.

That self-employment tax is 15.3% — 12.4% Social Security on net earnings up to $184,500 in 2026, and 2.9% Medicare with no ceiling — charged on 92.35% of net earnings, with half of it deductible against income tax. The 20% qualified business income deduction applies to both, because it's a deduction for pass-through business income and both are pass-throughs. Neither structure changes the other's arithmetic by a dollar.

What does change it is an S-corporation election, which an LLC can make and a sole proprietorship can't. Elect it and you become an employee of your own company: you pay yourself a salary with payroll tax on it, and take the rest as a distribution, which isn't subject to self-employment tax. The saving is real. So is the cost of getting it wrong.

2026 rates: 15.3% on 92.35% of net earnings for self-employment tax; 15.3% of salary in combined employer and employee FICA under the election. The 60% salary is a common starting point for a one-person service business, not a rule and not a safe harbour — the IRS standard is reasonable compensation for the work actually done, and courts have repeatedly recharacterised distributions as wages where the salary was too low. Ignores state payroll obligations and the effect on the QBI deduction, both of which move the answer.

Read the last column rather than the fifth. At $40,000 of profit the election earns you a few hundred dollars and a monthly payroll run; at $80,000 it's a few thousand, which is the point where it starts being obviously worth the trouble. That's the reasoning behind the rule of thumb you'll see everywhere — somewhere past $60,000–$80,000 of profit — and it's a range, not a threshold, because it moves with your salary, your state, and the fact that paying yourself a wage shrinks the 20% QBI deduction on what's left.

A sole proprietorship costs the state nothing. The only fee most sole proprietors pay is a fictitious-name or DBA filing — $10 to $100 in most counties — and only if they trade under a name that isn't their own. Everything in the LLC column below is the state's own published online filing fee, plus anything it bills shortly after and any tax it charges the entity regardless of profit.

Online filing fees, from each state's own schedule, with no registered-agent service and no formation company. New York's year-one figure uses the low end of the publication requirement — six weeks of notices in two county-chosen newspapers, plus a $50 certificate — which runs a few hundred dollars upstate and can pass $1,500 in Manhattan.

The spread is the point. In Ohio or Montana the decision costs less than a tank of fuel a year and there is very little to think about. In California the $800 annual franchise tax applies from the first year whether or not you made a dollar, so an LLC formed in January for a business that doesn't start until September has already cost $800 for nothing. In Massachusetts it's $520 to open and $520 every year after. Those states reward waiting until the business is real; the cheap ones don't punish acting early. Every state's fees are on one table here.

One cost that isn't on the table: the annual report. An LLC that misses one gets a late fee — Florida's is a flat $400 — and eventually administrative dissolution, which removes the protection you paid for while leaving you to find out later. A sole proprietorship cannot forget a deadline it doesn't have. If you're the kind of person who will genuinely not put a date in a calendar, that's an argument worth weighing honestly.

You can form an LLC at any point. Nothing about having traded as a sole proprietor first makes it harder, and the business doesn't start again — the customers, the reviews, the phone number and the reputation all carry over. What has to be redone is the paperwork underneath: a new EIN in the LLC's name (free, ten minutes, from the IRS), a new business bank account, the Stripe or Square account moved to the new entity, insurance reissued to the LLC, any licence or permit transferred, and existing client contracts assigned or reissued. It's an afternoon, not a project — but it is an afternoon, and doing it twice is why people who know they'll need one form it early.

The one thing that doesn't carry over is protection for what already happened. An LLC formed in June does nothing about a job you did in March. That's the argument for filing before the risky work rather than after it, and the reason the honest trigger list is short: the first employee, the first lease or loan, the first co-owner, the first contract with a liability clause, the first month where a bad outcome would cost more than you have. Any one of those is the moment.