You’ve finally taken the leap—you’re self-employed, landing clients, selling products, or offering services. But now the question hits: should you stay a sole proprietor, or form an LLC? It’s a decision that can shape your tax bill, your legal risk, and even how potential customers view your business.

Many entrepreneurs start as sole proprietors without even realizing it. That’s because it’s the default business structure in the eyes of the IRS and state governments. But just because it’s easy doesn’t mean it’s smart. An LLC offers layers of protection and potential tax advantages that could save you thousands over time.

Sole Proprietorship vs. LLC: What Are They, Really?

At their core, these are two ways of organizing your business. The key differences boil down to legal protection, credibility, taxes, and administrative burden.

Sole Proprietorship

• Default structure when you start doing business without registering a legal entity.
• No legal separation between you and your business.
• Easy to start and manage—often no formal paperwork required (aside from local licenses).

Limited Liability Company (LLC)

• State-recognized legal entity that separates your personal assets from business liabilities.
• Flexible tax options—default pass-through or elect S-Corp status for potential savings.
• More credibility with clients, banks, and partners.

The Tax Difference That Hits Your Wallet

Both sole proprietorships and single-member LLCs are taxed similarly—at least at first glance. They’re both “pass-through entities,” meaning profits and losses pass through to your personal tax return. But that’s just the start of the story.

Self-Employment Tax

Here’s where the real costs add up. As a sole proprietor, you pay self-employment tax on 100% of your net business income. That’s 15.3% for Social Security and Medicare, in addition to federal and state income taxes.

LLCs—at least initially—work the same way. But the advantage of the LLC is that you can elect to be taxed as an S-Corporation, which opens the door to a strategy that can reduce your self-employment tax liability by thousands.

Example:

Let’s say your business nets $80,000 in profit:

• Sole Proprietorship: Pay 15.3% SE tax on the full $80,000 = $12,240.
• LLC with S-Corp election: Pay yourself a $40,000 salary (subject to SE tax), and take $40,000 as distributions (no SE tax). SE tax = $6,120.

Tax savings: $6,120 per year. That’s money that stays in your pocket instead of going to the IRS.

Legal Liability: What’s at Stake?

Tax savings are great, but legal protection might be even more important—especially if your business deals with customers, contracts, products, or liability risks (which is basically every business).

Sole Proprietorship Risks

If your business is sued, defaults on a loan, or is involved in a legal dispute, your personal assets are at risk. That includes your home, car, savings, and even your future wages.

LLC Protection

With an LLC, your personal assets are legally separate from the business. This “corporate veil” means that if your business is sued, only the business’s assets are at risk—not your house, bank account, or retirement fund. It’s one of the main reasons business owners make the switch, especially as they grow.

Credibility and Business Growth

Perception matters. Clients, vendors, and lenders often take LLCs more seriously. It signals that you’re in it for the long haul, and you’ve taken the legal steps to operate professionally.

Banking and Loans

Opening a business bank account as a sole proprietor often requires a DBA (“doing business as”) name, and lenders may be more hesitant to offer credit. An LLC, on the other hand, makes it easier to establish business credit and access funding opportunities—including SBA loans.

Contracting and B2B Work

Many corporate clients require contractors to be incorporated or operate as an LLC before signing contracts. If you’re pitching yourself to bigger clients, being a sole proprietor might leave you off the table.

Startup Costs and Ongoing Requirements

One of the biggest reasons people hesitate to form an LLC is cost and paperwork. And yes, forming an LLC requires a bit more legwork than just calling yourself a business owner.

Sole Proprietorship

• Low or no startup cost.
• Usually only need a local business license or seller’s permit.
• No separate tax filings.

LLC

• Formation cost varies by state—usually between $50 and $500.
• Annual report fees and franchise taxes may apply.
• Requires separate tax filings if electing S-Corp status.

Still, these costs are often outweighed by the tax savings and legal protection—especially after your business begins generating steady income.

Real-World Examples: When to Stick and When to Switch

Freelancer Just Starting Out

If you’re testing a side hustle or earning under $10,000 a year, a sole proprietorship might work—for now. Keep costs low and focus on building your brand. Just make sure you track all income and expenses, and consider forming an LLC if your business starts gaining traction.

Consultant Earning $60K+/year

Now you’re in LLC territory. Not only will an LLC help with tax savings via S-Corp election, but it also protects your personal assets in case a client disputes a contract or demands a refund. You’re also more likely to get hired by other companies if you operate under a legal entity.

Online Seller with Inventory Risk

If you sell physical products and have inventory, you’re exposed to legal risk. A defective product or failed delivery could become a legal nightmare. An LLC offers a legal shield that could protect everything you’ve built.

How to Switch from Sole Proprietor to LLC

Already operating as a sole proprietor and ready to switch? The process is easier than you might think:

1. Choose a business name and check state availability.
2. File Articles of Organization with your Secretary of State.
3. Get an EIN (Employer Identification Number) from the IRS.
4. Open a business bank account in your LLC’s name.
5. Update contracts and business licenses to reflect the new structure.

Depending on your state, you may also need to publish a notice or file an annual report. After that, consider whether an S-Corp election makes sense—and if so, file IRS Form 2553.

Choose Structure with Strategy

There’s no shame in starting as a sole proprietor. It’s simple, fast, and requires almost no paperwork. But as your business grows—even a little—the risks and taxes grow with it. An LLC provides a safety net and opens up pathways for better tax strategies, more credibility, and peace of mind.

Every dollar you earn matters. The right structure helps you keep more of it—and protect what you’ve already earned. Whether you’re just beginning or leveling up, knowing the difference between a sole proprietorship and an LLC is more than a formality. It’s a strategy that can pay off big.