What is the difference between a Sole Proprietorship and a Company (LLC)?

Looking to start a business but don't know what entity structure to implement? 

There are in fact 5 different types of entity structures you may choose to trade under (not including non profit organisations or clubs).

They are:

• Sole Proprietorships
• Partnerships
• Company (LLC)
• Corporations
• Trusts

Sole Proprietorship

A sole proprietorship is a business run by an individual under their own name. The business and the individual are the same legal entity and subsequently the owner is personally liable for all the debts and liabilities of the business. There is no legal separation between yourself and your business. 

The good news is the costs to set up and mantain a sole proprietorshp business are very low. You will have full control over how the business is run and get to retain all the profits.

Partnership

A partnership is a business operated by two or more individuals. In the U.S., there are several types of partnerships: General Partnerships, Limited Partnerships (LPs), and Limited Liability Partnerships (LLPs).

A general partnership is not considered a separate legal entity, meaning partners are jointly and personally liable for all debts and obligations of the business. Limited Partnerships and LLPs, however, require a written certificate of formation or registration to be officially recognized under state law, although a full partnership agreement is still not legally mandatory. Even so, having a written partnership agreement is highly recommended, as it clearly defines each partner’s contributions, profit-sharing, decision-making authority, and procedures for adding or removing partners or handling a partner’s exit. Without it, default state rules apply, which may not reflect the partners’ intentions.

While partners give up some individual control over the business, partnerships allow owners to pool resources, skills, and experience, which can help the business grow. Partnerships are generally pass-through entities for tax purposes: profits and losses are allocated to each partner, who reports their share on their personal tax return. General partners are typically considered self-employed and may also owe self-employment taxes on their share of income.

The costs to establish and maintain a partnership are generally lower than for a corporation or LLC, though slightly higher than a sole proprietorship due to legal and administrative considerations. Properly structuring the partnership with professional legal and tax guidance can help minimize disputes and optimize tax outcomes.

Company (LLC)

An LLC, is a hybrid between a corporation and a partnership. Limited Liability Company (LLC) is legally recognized as its own entity, distinct from its members (owners). As the name suggests members (the owners) also enjoy limited liability.

An LLC’s members are only liable up to the amount they have invested or agreed to invest in the business. Once that contribution is made (in cash, property, or services), their personal assets are protected. Even if the LLC fails, members are not required to contribute additional funds unless they’ve personally guaranteed a loan or committed fraud.

Corporation

A corporation is a separate legal entity from its owners. Ownership is determined through the issuance of shares, which represent each shareholder’s stake in the company. In the U.S., the most common types of corporations are C Corporations (C Corps) and S Corporations (S Corps).

• C Corporations are taxed as separate entities. They pay corporate income tax on profits, and shareholders are taxed again on dividends received, resulting in double taxation.

• S Corporations are pass-through entities for tax purposes: profits and losses are reported on shareholders’ personal tax returns, avoiding double taxation, but they must meet specific eligibility requirements.

Shareholders’ liability is generally limited to the value of the shares they own, meaning personal assets are protected beyond their investment in the corporation.

Setting up and maintaining a corporation can be complex and costly, requiring legal filings with the state, adoption of corporate bylaws, and ongoing compliance such as annual reports and meetings. Corporations file their own tax returns, and for C Corps, the current federal corporate tax rate is 21% (as of 2023), which applies to profits earned by the company.

One of the advantages of corporations is that ownership can be easily transferred by selling or assigning shares, without affecting the ongoing operations of the company. This makes corporations attractive for raising capital, bringing in investors, or planning for succession

Trust

A trust is a legal arrangement in which a trustee holds and manages property for the benefit of beneficiaries, according to the terms of a trust agreement. While a trust is not considered a separate legal entity like a corporation, it is treated as a taxable entity for certain purposes and may be required to file its own tax return.

The trustee can be an individual or an institution, and is responsible for managing the trust property in the best interests of the beneficiaries. There are several types of trusts, including revocable living trusts, irrevocable trusts, and testamentary trusts, each with its own advantages, rules, and tax implications.

Some trusts, like irrevocable trusts, may be required to distribute income to beneficiaries, who then report it on their personal tax returns, which can help manage the overall tax burden. Trusts can be complex and costly to set up and administer, often requiring professional legal and tax guidance