The Sole Proprietorship: What You Already Are

If you’re earning money from a business and haven’t filed any formation paperwork with your state, you’re already a sole proprietor. That’s the default. No registration, no filings, no operating agreement. You report your business income on Schedule C of your personal return, you pay self-employment tax on the net profit, and that’s it.

The simplicity is the appeal. There’s nothing to set up and almost nothing to maintain. You might need a local business license or a DBA (“doing business as”) registration if you’re operating under a name other than your own, but the paperwork is minimal. Annual cost: close to zero.

The downside is that you and the business are legally the same entity. If someone sues the business, they’re suing you. If the business owes a debt it can’t pay, your personal savings, your car, your home equity — all of that is on the table. For a freelance writer billing $3,000 a month with no employees, that risk is abstract. For a contractor doing $500,000 in renovation work, that risk is very real.

The LLC: What It Does and What It Doesn’t

An LLC — limited liability company — is a legal entity you form by filing articles of organization with your state. In New York, the filing fee is $200, plus you’re required to publish a notice in two newspapers (which can cost $300-$1,500 depending on the county). Other states are cheaper — many charge $50-$150 to form an LLC.

What the LLC gives you is liability protection. The business becomes its own legal person. If the business gets sued, the plaintiff can go after the LLC’s assets, but your personal assets are generally off limits. That’s the “limited liability” part.

But it’s not a force field. Courts can “pierce the veil” and hold you personally liable if you treat the LLC as your personal piggy bank — mixing personal and business funds, not keeping basic records, undercapitalizing the business. The protection only works if you actually treat the LLC like a separate entity. That means a separate bank account, at minimum. Ideally a separate credit card, clean books, and an operating agreement on file even if you’re the only member.

Tax Treatment: Exactly the Same (By Default)

Here’s the part that surprises people: a single-member LLC and a sole proprietorship are taxed identically. The IRS treats a single-member LLC as a “disregarded entity” — meaning it’s invisible for tax purposes. You still file Schedule C. You still pay self-employment tax on the net profit. The forms are the same, the rates are the same, the deductions are the same.

Forming an LLC does not, by itself, change your tax bill by a single dollar.

The tax picture changes only when you make an additional election. A single-member LLC can elect to be taxed as an S-corp by filing Form 2553 with the IRS. That’s a separate decision from forming the LLC, and it comes with its own requirements — running payroll, paying yourself a reasonable salary, filing Form 1120-S. If the S-corp election makes sense for your income level, the LLC is the vehicle that lets you make it. But the LLC alone doesn’t change your taxes.

Self-Employment Tax: Same Story for Both

Self-employment tax is 15.3% on the first $168,600 of net earnings (2024 figure, adjusted annually per Social Security Administration), then 2.9% on everything above that (IRC Section 1401). This applies to sole proprietors and single-member LLC owners equally. The LLC doesn’t reduce your SE tax exposure.

The only way to reduce self-employment tax within either structure is to elect S-corp treatment. As an S-corp, only your W-2 salary is subject to payroll taxes — distributions above the salary are not. But again, that requires the S-corp election, not just the LLC.

We see people form LLCs every year thinking it will lower their tax bill. It won’t. Not unless they pair it with the right tax election, and even then, the numbers only work above a certain income threshold.

Costs and Ongoing Requirements

Sole Proprietorship

Startup cost: $0 to $75 for a DBA filing. Annual cost: effectively nothing beyond your tax preparation. No annual reports, no state renewal fees (in most states), no registered agent requirement.

LLC

The costs stack up faster than people expect. Formation fees vary by state — $200 in New York, $70 in California, $100 in most other states. Then there are annual or biennial renewal fees: New York charges $9 per year, California charges $800 per year (the infamous franchise tax, regardless of whether you earn any income), and other states range from $0 to $500.

New York adds the publication requirement, which is unique and annoying. Within 120 days of formation, you must publish a notice in two newspapers in your county of formation for six consecutive weeks. Manhattan publications run $300-$500. Albany County can run over $1,500. It’s a cost that exists for no particularly good reason, but ignoring it means the state can suspend your LLC’s authority to do business.

You’ll also want an operating agreement, even if you’re a single member. It’s not legally required in every state, but it’s evidence that you’re treating the LLC as a real entity — which matters if the liability protection ever gets tested in court.

When to Form the LLC

There’s no universal income threshold where an LLC becomes mandatory. The decision is about risk, not revenue. Here are the triggers that should push you toward forming one:

You’re signing contracts with clients. If a contract dispute turns into a lawsuit, you want the LLC between you and the claim. A sole proprietor who breaches a $50,000 contract has personal assets on the line. An LLC member does not (assuming the veil is intact).

You have employees or subcontractors. Employment lawsuits — wrongful termination, workplace injury, discrimination claims — are expensive. An LLC provides a layer of protection that a sole proprietorship doesn’t.

You’re in a high-liability industry. Construction, consulting, events, real estate, anything where mistakes can cause significant financial harm to others. If your work could result in a lawsuit, the LLC is worth the cost.

You own personal assets worth protecting. If you have a home with equity, savings accounts, investment portfolios — you have something to lose. A college student selling t-shirts online with $200 in a checking account doesn’t have the same risk profile as a 40-year-old consultant who owns a brownstone.

You want credibility. Some clients, particularly larger companies, prefer to work with LLCs. It signals that you’re a real business, not someone freelancing on the side. That perception matters in certain industries more than others.

Multi-Member LLCs: The Partnership Default

Once you add a second owner, the tax picture changes. A multi-member LLC is taxed as a partnership by default, which means filing Form 1065 and issuing K-1s to each member. The partnership return is an information return — the LLC itself doesn’t pay tax, but each member reports their share of income on their personal return.

Partnership taxation is more complex than Schedule C filing. You’ll need a CPA for the return (partnership returns have enough moving parts that self-filing is a bad idea), and the operating agreement needs to address profit sharing, capital contributions, distributions, and what happens if a member leaves.

A multi-member LLC can also elect S-corp treatment, following the same rules as a single-member LLC. The decision framework is similar: if the members’ combined compensation is high enough for payroll tax savings to exceed the compliance costs, it’s worth considering. If not, stick with the default partnership treatment.

The EIN and Business Bank Account

Whether you’re a sole proprietor or an LLC, get an EIN (Employer Identification Number) from the IRS. It’s free, takes five minutes online, and keeps you from putting your Social Security number on invoices and W-9 forms.

Open a dedicated business bank account. This is non-negotiable for an LLC — commingling personal and business funds is the fastest way to lose your liability protection. For a sole proprietor, it’s not legally required, but it makes bookkeeping dramatically easier and looks more professional.

We tell every new client the same thing: separate the money from day one. Untangling a year’s worth of mixed personal and business transactions at tax time is expensive, time-consuming, and entirely avoidable.

The Bottom Line on Choosing

If you’re just getting started, earning modest income, and not in a high-risk industry, a sole proprietorship is fine. Don’t spend money forming an LLC before you’ve validated that the business actually works.

Once you’re earning consistent income, signing real contracts, or accumulating personal assets worth protecting, form the LLC. It’s not about the tax benefits (there aren’t any by default). It’s about putting a legal barrier between your business and your personal life.

And when the income gets high enough that self-employment tax starts hurting, that’s when you talk to a CPA about the S-corp election. The LLC makes that election possible, but the timing depends on your numbers. Get the math done before you file anything. Don’t forget that regardless of your structure, quarterly estimated tax payments are still your responsibility as a business owner. And if you’ve put off filing returns while figuring out your structure, our back taxes guide can help you get current. For owners with crypto holdings, the reporting obligations apply no matter which entity type you choose.

Sources & References

• IRS — Single Member Limited Liability Companies
• IRS — Sole Proprietorships
• 26 U.S.C. Section 1401 — Rate of Tax (Self-Employment)
• IRS — About Schedule C (Form 1040)
• IRS — About Form 1065, U.S. Return of Partnership Income
• IRS — Apply for an EIN Online
• Social Security Administration — Contribution and Benefit Base
• New York Department of State — Limited Liability Companies
• California Franchise Tax Board — LLC Information