If you’re a contractor, one of the first big questions you’ll face is how to set up your business. Should you stick with a sole proprietorship or form an LLC? The choice you make can affect everything from your taxes to your personal liability.
Don’t worry. We’ll break down both options in plain, simple terms. No confusing legal talk, just clear info to help you understand how each works and which might be the best fit for you.
What is a Sole Proprietorship?
A sole proprietorship is the simplest way to run a business. Basically, you and your business are considered the same thing. There’s no paperwork to file to create it. You simply start working and earning money as a contractor, and you automatically have a sole proprietorship.
Think of a sole proprietorship like this: you’re a painter and you start painting houses for money. You might call your business “John’s Painting,” but legally, there’s no separation between you (John) and your painting business. It’s all just you.
Key features of a sole proprietorship:
- Easiest and cheapest business to start
- You have complete control over everything
- All profits go directly to you
- You report business income on your personal tax return
- You’re personally responsible for all business debts and liabilities
What is an LLC?
LLC stands for Limited Liability Company. It’s a type of business structure that sits somewhere between a sole proprietorship and a corporation. The big difference is that an LLC creates a separate legal entity for your business.
Using our painting example: If you form “John’s Painting LLC,” you’ve created a business entity that exists separately from you as a person. It’s like creating a protective bubble around your business activities.
Key features of an LLC:
- Provides personal liability protection
- Can be owned by one person (single-member LLC) or multiple people
- More flexible tax options
- Requires registration with your state
- Has more paperwork and compliance requirements than a sole proprietorship
Understanding your business structure is just one part of financial planning. For a complete picture of planning your business finances, check out our guide on What Are Financial Projections and How To Do One.
Key Features of an LLC vs. Sole Proprietorship (Comparison Table)
Here’s a simple side-by-side comparison of these two business structures:
Feature | Sole Proprietorship | LLC |
Formation | Automatic, no filing required | File formation documents with state |
Cost to form | $0 (maybe local business license) | $40-$500+ depending on state |
Personal liability protection | None | Yes |
Tax filing | Schedule C with personal tax return | Schedule C (single-member) or partnership return (multi-member) |
Self-employment tax | Yes, on all profits | Yes, on all profits (typically) |
Ongoing requirements | Minimal | Annual reports, fees, maintaining records |
Raising money | Harder (personal loans, etc.) | Easier (can add members, etc.) |
Business longevity | Ends when owner dies/quits | Can continue regardless of owner changes |
LLC vs. Sole Proprietorship
Let’s break down the main differences in more detail:
Formation
Sole Proprietorship: Starting a sole proprietorship is super easy. You don’t have to file any special paperwork with the state. You might need to:
- Get a local business license
- Register a business name (if using something other than your personal name)
- Get any permits specific to your type of work
LLC: Forming an LLC takes more effort:
- File “Articles of Organization” with your state
- Pay a filing fee ($40-$500+ depending on the state)
- Create an operating agreement (not required in all states, but recommended)
- Publish a notice in a local newspaper (required in some states)
- Get an EIN (Employer Identification Number) from the IRS
Operations and Management
Sole Proprietorship: You have complete control and maximum flexibility:
- Make all business decisions yourself
- No formal meetings or voting required
- No separation between business and personal finances (though keeping separate accounts is recommended)
LLC: An LLC gives you more structure:
- Can be managed by members (owners) or appointed managers
- Should follow the operating agreement rules
- Should keep business finances completely separate from personal
- May need to document major company decisions
Tracking your business finances properly is crucial regardless of which structure you choose. Our article on What is a Ledger Balance? can help you understand the basics of financial tracking.
Taxes
Sole Proprietorship: Tax filing is straightforward:
- Report all business income and expenses on Schedule C of your personal tax return
- Pay self-employment tax (15.3%) on all profits
- No separate business tax return needed
LLC: LLCs have flexible tax options:
- By default, single-member LLCs are taxed just like sole proprietorships
- Multi-member LLCs are taxed as partnerships by default
- Can elect to be taxed as an S-Corporation or C-Corporation, which might save on self-employment taxes
- May require additional tax forms
Understanding the difference between various financial metrics can help you make better business decisions. Our article on Gross Profit vs. Net Profit: What’s the Difference? explains these important concepts.
Legal Protection
Sole Proprietorship: There’s no separation between you and your business:
- You’re personally responsible for all business debts
- Your personal assets (home, car, savings) are at risk if your business is sued
- Personal bankruptcy might be necessary if business debts become overwhelming
LLC: An LLC provides a legal shield:
- Your personal assets are generally protected from business debts and lawsuits
- Creditors usually can’t go after your personal property to satisfy business debts
- The “limited liability” in LLC refers to this protection
This is probably the biggest difference between the two business structures, and for many contractors, it’s the main reason to consider an LLC.
Paperwork and Compliance
Sole Proprietorship: Minimal ongoing requirements:
- File your annual personal tax return with Schedule C
- Renew any business licenses
- No special state filings or fees
LLC: More ongoing requirements:
- Annual or biennial reports to the state
- State fees (typically $50-$500 per year)
- Maintain separate business records and accounts
- May need to hold and document regular meetings
Mike runs a small contracting business specializing in kitchen remodels. He started as a sole proprietorship because it was simple and free to set up. After a year, business was booming but Mike started worrying about liability.
He had two close calls where clients were unhappy with subcontractor work, and he realized that if he ever got sued, his personal assets (including his family home) would be at risk.
After consulting with an accountant, Mike formed an LLC, opened separate business bank accounts, got proper business insurance, and created professional invoices with his new LLC name.
The peace of mind was worth the additional $300 in formation fees and annual compliance costs, plus his accountant showed him how to potentially save on self-employment taxes by taking some income as distributions rather than salary.
Should You Choose an LLC or a Sole Proprietorship?
The right choice depends on your specific situation. Here are some guidelines:
A sole proprietorship might be better if:
- You’re just starting out with minimal business activity
- You have minimal liability risk (like a consultant working from home)
- You want the absolute simplest and cheapest option
- You don’t have many valuable personal assets to protect
- You plan to keep the business very small
An LLC might be better if:
- Your work carries higher liability risks (construction, childcare, food service)
- You have personal assets you want to protect (house, savings, investments)
- You might want to bring on business partners later
- You want your business to look more established to clients
- You might need business loans or want to grow significantly
Remember that you can always start as a sole proprietorship and convert to an LLC later as your business grows. Many successful contractors follow this path.
Regardless of which structure you choose, proper financial management is essential. Our Invoice Maker can help you create professional invoices that help you get paid faster and track your income more effectively.
Breaking Even in Business
No matter which business structure you choose, knowing your break-even point is crucial for success. Our guide on the Break-Even Point Formula can help you calculate exactly how much you need to earn to cover all your costs.
Paying Yourself as a Business Owner
Whether you operate as a sole proprietorship or LLC, you’ll need to understand how to pay yourself. For more information on creating proper payment records, check out What is a Pay Stub? to learn about documenting your income correctly.
Final Thoughts
Choosing between a sole proprietorship and an LLC is a big decision, but there’s no one-size-fits-all answer for contractors. It really comes down to your risk tolerance, growth plans, and financial situation. Many contractors start as sole proprietors to keep things simple and affordable, then switch to an LLC later as their business grows and they have more to protect.
No matter which structure you choose, remember that it’s just one piece of the puzzle. Keeping your business and personal finances separate, staying on top of taxes, carrying the right insurance, and maintaining clear records all play a key role in your success.
If you’re still unsure which option is best for you, consider consulting with a business attorney or accountant who specializes in working with contractors. The small cost of professional advice can save you from much bigger headaches down the road.
FAQs about LLC vs Sole Proprietorship for Contractors
Yes. Many contractors do as their business grows. Just file as an LLC with your state and update your info with banks, clients, and the IRS.
No. You’re still at risk if you mix personal and business funds, personally guarantee loans, act negligently, or break the law. Insurance is still important.
It depends. LLCs are taxed like sole proprietors by default, but you can elect other tax options (like S-Corp) that may save money. Ask a tax professional.
Sole proprietors without employees can use their SSN, but LLCs should get an EIN to keep finances separate.
Yes. You’ll need an EIN and must follow payroll rules. But an LLC isn’t required.
