This article is for informational and educational purposes only and does not constitute legal, tax, financial, or professional business advice.
You started making money doing your thing. Now someone told you that you need to “get an LLC” and suddenly you’re drowning in acronyms and legal jargon. Here’s the truth: you probably don’t need to decide this today. But when you do, here’s everything you need to know—in actual English.
First: What These Words Actually Mean
Let’s start by translating the business-speak into human language.
Sole Proprietorship
This is what you are by default if you start making money and don’t do anything official about it.
You’re a freelance designer? Sole proprietor.
You sell handmade jewelry on Etsy? Sole proprietor.
You started consulting on the side? Sole proprietor.
No paperwork. No filing fees. You just… are one.
From a legal perspective, you and your business are the same entity. There’s no separation. Your business income is your income. Your business expenses are your expenses. You report everything on your personal tax return.
Simple? Yes.
Risky? Also yes. (We’ll get to that.)
Limited Liability Company (LLC)
An LLC creates a legal separation between you as a person and your business as an entity.
Think of it like this: you create a protective bubble around your business. The business has its own name, its own bank account, its own tax ID number. Legally, it’s separate from you.
This separation matters for one big reason: liability protection.
If your business gets sued or goes into debt, generally speaking, only the business’s assets are at risk—not your personal house, car, or savings.
(We say “generally” because there are exceptions. Nothing is bulletproof.)
To form an LLC, you file paperwork with your state and pay fees. Then you maintain it with annual filings and fees. More structure, more protection, more admin.
The Real Question: When Does the Structure Actually Matter?
Here’s what most articles won’t tell you: for many small businesses, especially when you’re just starting, it doesn’t matter that much.
If you’re making $500 a month selling prints on Etsy, you don’t need an LLC. You need customers.
If you’re doing freelance writing on the side while working full-time, you probably don’t need an LLC. You need clients.
But there are specific situations where the structure starts to matter a lot. Let’s break them down.
When to Stay a Sole Proprietor
A sole proprietorship makes sense if:
1. You’re testing an idea
You’re not sure if this business will work. You’re experimenting. You’re seeing if people will actually pay you for this thing.
Don’t spend $800 on LLC fees to test a business idea. Just start. See if it works. You can always formalize later.
2. Your business is low-risk
You’re a freelance writer. A virtual assistant. A consultant. You’re not manufacturing products. You don’t have a storefront. You’re not hiring employees.
The chance of getting sued is relatively low. Your laptop is your biggest business asset.
Sole proprietorship is fine here.
3. You’re making under $50K/year from the business
This isn’t a hard rule, but if your business income is small, the administrative hassle and cost of an LLC might not be worth it yet.
Keep it simple. Focus on growing revenue. Formalize when it makes sense.
4. You want maximum simplicity
Sole proprietorships require almost no paperwork beyond your normal tax return.
You don’t need a separate bank account (though you should have one anyway for sanity).
You don’t need annual state filings.
You don’t need to maintain corporate formalities.
It’s just you, doing your thing, reporting your income.
5. You’re the only owner and plan to stay that way
If it’s just you and it’s always going to be just you, sole proprietorship is straightforward.
Want to bring in a partner later? You’ll need to change structures anyway.
When to Form an LLC
An LLC starts making sense when:
1. Your business has real liability risk
You’re selling physical products that could harm someone.
You have clients coming to a physical location.
You’re hiring employees.
You’re signing contracts that could go sideways.
You’re in an industry where people sue (real estate, construction, fitness, health/wellness).
If there’s any reasonable chance someone could sue your business, an LLC protects your personal assets.
Example: You run a small bakery. Someone gets food poisoning and sues. With an LLC, they can sue the business and potentially take the business’s assets—but they generally can’t take your personal house.
With a sole proprietorship? Everything you own is on the table.
2. You have significant personal assets to protect
If you own a home, have substantial savings, own rental property, or have assets you can’t afford to lose—an LLC provides a shield.
If you’re 25, renting an apartment, with $3,000 in savings? Honestly, there’s not much to protect yet. Sole proprietorship is probably fine.
If you’re 40, own a house, have retirement savings, and own a car outright? LLC makes more sense.
3. You’re making real money (50K+ per year)
Once your business is generating substantial income, the tax flexibility of an LLC becomes valuable.
An LLC can choose how it’s taxed. You can elect S-corp status, which can save you thousands in self-employment taxes.
(Talk to an accountant about this. Seriously. The tax savings can pay for the LLC fees many times over.)
4. You want credibility with clients or investors
Let’s be honest: “Sarah Johnson Consulting LLC” sounds more established than “Sarah Johnson, Freelancer.”
Some clients (especially corporate ones) prefer to work with LLCs or corporations rather than individuals.
If you’re trying to land bigger clients, an LLC can help.
5. You want to bring in partners or investors later
An LLC structure makes it easier to add members, bring in investors, or sell ownership stakes.
With a sole proprietorship, adding a partner means dissolving and starting over as a partnership or LLC.
6. You’re launching a brand you plan to scale
If you’re building a product line, a coaching business, a course platform—something you intend to grow significantly—start with an LLC.
It’s easier to start with the right structure than to migrate later.
The Liability Protection Conversation We Need to Have
The biggest difference between sole proprietorship and LLC is liability protection. Let’s be very clear about what this means.
Sole Proprietor Liability
You and the business are legally the same. If the business owes money or gets sued, you personally owe that money or face that lawsuit.
Someone sues your business and wins? They can come after:
- Your personal bank accounts
- Your house
- Your car
- Your retirement savings
- Anything you own
Scary? Yes. Realistic for most small service businesses? Not really.
But the risk is there.
LLC Liability Protection
The LLC is a separate legal entity. If the LLC gets sued or goes into debt, generally only the LLC’s assets are at risk.
Your personal assets are protected (with some big exceptions we’ll get to).
Someone sues your LLC and wins? They can take:
- Money in the business bank account
- Business equipment and inventory
- Business property
But NOT:
- Your personal house
- Your personal savings
- Your personal car
The Big Exception: Personal Guarantees
Here’s where the LLC protection gets tricky.
If you personally guarantee a business loan or lease, you’re on the hook personally—LLC or not.
Most banks require personal guarantees for small business loans. Most landlords require them for commercial leases.
So the liability protection isn’t absolute. But it still matters for things like customer lawsuits, vendor disputes, or general business debts.
The Other Big Exception: Negligence
If you personally do something negligent or illegal, an LLC won’t protect you.
You can’t commit fraud and hide behind your LLC.
You can’t personally injure someone through negligence and claim LLC protection.
The protection is for business liabilities, not personal misconduct.
Let’s Talk Money: What Each Structure Costs
Sole Proprietorship Costs
Setup: $0 (you’re already one if you’re in business)
Annual fees: $0
Tax filing: Schedule C with your personal tax return (no extra cost if doing your own taxes)
Total annual cost: $0 – $500 (if you hire an accountant)
LLC Costs
Setup: $50 – $500 depending on your state
Annual fees: $0 – $800 depending on your state (California is $800/year, ouch)
Registered agent: $0 – $300/year if you use a service
Tax filing: Similar to sole proprietor unless you elect corp status
Accountant fees: $500 – $2,000/year (recommended, especially if electing S-corp)
Total annual cost: $300 – $3,000+ depending on state and complexity
Is It Worth It?
If you’re in California making $30K/year from your side hustle, that $800 annual fee might feel steep.
If you’re in Delaware making $100K/year and can save $5,000 in taxes with S-corp election, absolutely worth it.
Do the math for your specific situation.
Tax Differences (The Part Everyone Gets Confused About)
Here’s the truth: by default, there’s no tax difference between a sole proprietorship and a single-member LLC.
Both are “pass-through” entities. Income passes through to your personal tax return. You pay the same taxes.
Both pay self-employment tax (15.3% for Social Security and Medicare) on net profit.
Both file Schedule C with Form 1040.
However, an LLC has tax flexibility that a sole proprietorship doesn’t.
The S-Corp Election
Here’s where it gets interesting.
An LLC can elect to be taxed as an S-corporation. This can save you thousands in self-employment taxes.
How it works:
Instead of paying 15.3% self-employment tax on all your profit, you pay yourself a “reasonable salary” (subject to employment taxes), and take the rest as distributions (not subject to self-employment tax).
Example:
Your LLC makes $100K profit.
As a sole proprietor or default LLC:
You pay ~$15,300 in self-employment tax on the full $100K.
As an S-corp:
You pay yourself $60K salary (employment taxes on this)
You take $40K as distributions (no self-employment tax on this)
You save ~$6,000 in taxes.
(These are simplified numbers. Talk to an accountant. Seriously.)
Catch: S-corp election comes with more complexity. Payroll. Quarterly filings. Definitely need an accountant.
Rule of thumb: S-corp election usually makes sense when your business profits exceed $60K-$80K/year.
The Annoying Admin Stuff
Sole Proprietorship Admin
- File Schedule C with your tax return
- Pay estimated quarterly taxes
- Keep business records
That’s it.
LLC Admin
- File Articles of Organization when forming
- Create an Operating Agreement (even if you’re the only member)
- Get an EIN from the IRS
- Open a business bank account
- File annual reports with your state
- Pay annual state fees
- Maintain corporate formalities (keep business and personal finances separate)
- File taxes (Schedule C by default, or corp returns if you elect)
- Pay estimated quarterly taxes
More work? Yes. Complicated? Not really. Just more steps.
The Decision Framework
Still not sure? Use this framework:
Stay a Sole Proprietor If:
- You’re testing a business idea
- You’re making under $50K/year
- Your business is low-risk (service-based, no products, no employees)
- You have minimal personal assets to protect
- You want maximum simplicity
- You can’t afford LLC fees right now
Form an LLC If:
- You’re selling products (especially anything that could cause harm)
- You have employees
- You’re making $50K+/year
- You have significant personal assets (house, savings, etc.)
- You’re in a high-liability industry
- You want credibility with bigger clients
- You plan to scale significantly
- You want tax optimization options (S-corp election)
Consider an LLC When:
- You’re signing your first commercial lease
- You’re hiring your first employee
- You’re launching a product line
- Your annual profit hits $60K+ (S-corp benefits kick in)
- You’re quitting your day job to do this full-time
How to Actually Form an LLC (If You Decide To)
It’s not as complicated as the internet makes it seem.
Step 1: Choose a business name
Check if it’s available in your state. Make sure it includes “LLC” or “Limited Liability Company.”
Step 2: File Articles of Organization
Go to your state’s Secretary of State website. Fill out the form. Pay the fee ($50-$500 depending on state).
This can be done online in 20 minutes for most states.
Step 3: Get an EIN
Go to IRS.gov. Apply for an Employer Identification Number. Free. Takes 10 minutes.
Step 4: Create an Operating Agreement
Even if you’re the only member, create an Operating Agreement. It outlines how your LLC operates.
Templates are available online. Or pay a lawyer $500-$1,000 to draft one.
Step 5: Open a business bank account
Separate business and personal finances. This is crucial for maintaining liability protection.
Step 6: Maintain it
File annual reports. Pay annual fees. Keep business money separate from personal money.
DIY or Use a Service?
DIY: Total cost = state filing fee ($50-$500). Takes a few hours of your time.
Service (LegalZoom, Incfile, etc.): Total cost = $300-$800. They handle paperwork for you.
Lawyer: Total cost = $1,000-$3,000. Custom operating agreement, personalized advice.
For most simple single-member LLCs, DIY or a formation service is fine.
If you have multiple members or complex needs, hire a lawyer.
When to Switch from Sole Proprietor to LLC
You don’t have to decide this on day one. It’s okay to start as a sole proprietor and switch later.
Common triggers for switching:
- Revenue milestone: You hit $50K-$75K in annual profit
- First employee: You’re hiring someone
- First major contract: You’re signing a big contract with liability implications
- Product launch: You’re selling physical products
- Going full-time: You quit your day job
- Asset protection: You buy a house and suddenly have something to lose
Switching is straightforward: form the LLC, transfer business assets, close out the sole proprietorship for tax purposes.
Common Mistakes to Avoid
1. Forming an LLC too early
You made $2,000 last year and spent $800 on LLC fees. That’s 40% of your profit on admin.
Wait until it makes financial sense.
2. Treating your LLC like a sole proprietorship
If you form an LLC but mix personal and business money, don’t maintain formalities, don’t keep records—a court can “pierce the corporate veil” and hold you personally liable anyway.
If you’re going to form an LLC, do it right.
3. Not getting an EIN
Even sole proprietors benefit from an EIN. It protects your Social Security number and makes you look more professional.
It’s free. Get one.
4. Assuming LLC = no personal liability ever
See the exceptions above. LLC protection isn’t absolute.
5. Not talking to an accountant about taxes
Seriously. A good accountant can save you way more than they cost, especially when it comes to S-corp elections and deductions.
The Questions You’re Actually Asking
“Do I need an LLC if I’m just freelancing?”
Probably not, especially if you’re just starting. But if you’re making good money ($50K+) or working with big clients, it’s worth considering.
“Can I have a different business name without an LLC?”
Yes! File a “Doing Business As” (DBA) with your county. Costs $20-$100. Lets you operate under a business name as a sole proprietor.
“Will an LLC save me money on taxes?”
Not by default. But the S-corp election option can save you thousands once you’re making enough money.
“Is it hard to switch from sole proprietor to LLC?”
Nope. Form the LLC, transfer assets, update your contracts and bank accounts. Not complicated.
“Do I need a lawyer?”
For a simple single-member LLC? Probably not. For multiple members or complex situations? Yes.
“What about insurance?”
Good question! Even with an LLC, get business insurance. Liability insurance protects you in ways an LLC can’t.
LLC + insurance = maximum protection.
The Bottom Line No One Tells You
Here’s the truth that all the legal websites won’t say:
Most of the time, when you’re just starting, it doesn’t matter as much as you think.
The internet will scare you into thinking you need an LLC on day one or you’ll lose everything.
That’s not true.
Millions of successful freelancers, consultants, and service providers operate as sole proprietors for years with zero problems.
The structure matters, yes. But not as much as:
- Actually getting clients
- Delivering good work
- Making money
- Building your business
Don’t let business structure paralysis stop you from starting.
Start as a sole proprietor if you’re unsure. Get customers. Make money. Then formalize when it makes sense.
The best business structure is the one that doesn’t stop you from building your business.
Your Next Step
If you’re just starting: Don’t overthink this. Start as a sole proprietor. Focus on getting customers.
If you’re making $50K+/year: Talk to an accountant about whether an LLC (and S-corp election) makes sense for your taxes.
If you’re in a high-liability business: Form an LLC now. Protect yourself.
If you have significant assets: Form an LLC. Don’t risk your house to save $500 in fees.
And regardless of structure: Get business insurance. Keep good records. Separate business and personal finances.
That matters more than the letters after your business name.
This article is for informational and educational purposes only and does not constitute legal, tax, financial, or professional business advice.
Resources
SBA: Choose a Business Structure
US Chamber of Commerce: Sole Proprietorship vs. LLC
