LLC vs sole proprietorship: which a new business needs

If you sell something on your own and haven’t registered a company, you’re already a sole proprietor: there’s nothing to file and nothing to pay. An LLC adds a legal line between the business’s debts and your personal assets, and that line has gaps. It doesn’t change your taxes by default, because a one-owner LLC files the same Schedule C and pays the same self-employment tax. It does add costs every year, and they vary a lot by state: as of October 2026, Kentucky charges $40 to form one and $15 a year after that, while California charges $70 to form one and an $800 tax every year. So the question isn’t which structure is better. It’s whether the risks this business carries are worth the fee yet.

A sole proprietorship: you may already be one

The SBA puts it plainly in its guide to choosing a business structure: if you do business without registering as another type, you’re automatically a sole proprietorship. The day you take money for a cake, a website or a repair, you are one.

It may still take two things:

• Licenses and permits your city, county or state requires for the work. These apply whatever the structure, so an LLC doesn’t get you out of them.
• A trade name filing (a DBA, for “doing business as”) if you trade under a name other than your own. Where you file depends on the state, and sometimes it’s the county.

The catch is that you and the business are the same person in law. The SBA’s guide says you can be held personally liable for the business’s debts and obligations, so a supplier, lender or court judgment the business can’t pay can come after your own savings and property.

What an LLC adds, and what it doesn’t protect

An LLC (limited liability company) is a business you register with your state. You file articles of organization, name a registered agent with an address in the state to receive legal papers, and write an operating agreement that says who owns what, which is worth having even where the state doesn’t require one. Once the LLC exists, the business’s debts and lawsuits are generally the company’s, not yours.

The SBA’s guide says an LLC protects you from personal liability “in most instances”, which is not the same as all of them. Three gaps catch new owners most often:

1. Personal guarantees. A new LLC has no credit history, so a bank, a landlord or an equipment lender will often ask the owner to sign personally. If you sign, you owe that debt yourself, LLC or not.
2. Your own mistakes. The LLC shields you from the company’s debts, not from your own actions. If you personally hurt someone or damage their property, say by doing a job carelessly, the claim can reach you as well as the company.
3. Mixing the money. Pay your groceries from the business account, take customer payments into your personal one or skip the company’s records, and a court can decide that you and the LLC are really the same and set the protection aside. Lawyers call it piercing the corporate veil.

An LLC only limits what a claim can reach; general liability or professional liability insurance is what pays it. For work where a customer could get hurt or lose money through a mistake, get an insurance quote before you file for the LLC.

Taxes: the same by default

This is where most of the sales pitches for LLCs go wrong. By default, the IRS ignores a one-owner LLC for income tax: its page on single-member LLCs calls it an entity “disregarded as separate from its owner,” and says the owner pays self-employment tax the same way a sole proprietor does. By default, either way, you:

• report the profit or loss on Schedule C with your own Form 1040;
• pay self-employment tax for Social Security and Medicare, 15.3% at the IRS’s rate, once your net earnings from self-employment reach $400 in a year;
• pay income tax on the profit whether or not you take it out of the business;
• may need to pay estimated tax during the year rather than all of it in April.

The difference comes later, if at all. An LLC can elect to be taxed as a corporation, including as an S corporation, which changes how the owner’s pay is taxed. That’s a decision to make with an accountant once profits are steady and sizeable, it brings payroll and extra filings of its own, and it isn’t a reason to form an LLC in month one.

One smaller point: the IRS says a one-owner LLC with no employees and no excise taxes doesn’t need an EIN (an employer identification number) and can use the owner’s own tax number, but it also expects most new ones to get one, because banks usually ask for one and some states require it. Either structure can get one free from the IRS in one sitting.

What each costs to start and keep

A sole proprietorship costs nothing to form. The costs it can have, a DBA filing and local licenses, an LLC has as well.

An LLC adds these, all set by the state:

• The filing fee to form it: $40 in Kentucky, on the Kentucky Secretary of State’s fee list, and $70 in California, as of October 2026. Other states charge more; your Secretary of State’s office (or its equivalent) lists the fee.
• A yearly or two-yearly report: $15 a year in Kentucky, and $20 every two years in California for the Statement of Information.
• State taxes and other extras: California’s Franchise Tax Board charges an $800 annual tax on every LLC organized or doing business there, due even in a year you don’t trade, until you cancel the LLC. Some other states charge a yearly fee or tax of their own, and a few require a newspaper notice of the new company.
• A registered agent: free if you can act as your own with an address in the state; a service charges a yearly fee.

A filing service fills in the form and files it for you. The state fee is the same either way, and the extras (a registered agent, an annual plan, an EIN the IRS gives free) are where the bill grows: it saves time, not money. The Toolbox has the IRS’s own EIN application, a filing service with its prices, and business bank accounts with no monthly fee.

Count the yearly cost as a fixed cost. An example, to show the sum: an LLC in California costs at least $800 a year, about $67 a month, before anything is sold. If each sale leaves $20 after its own costs, that’s more than three extra sales every month just to cover the LLC. In Kentucky, the same sum is $15 a year, less than one sale. Put the figure into your break-even point, and list it with the other monthly costs in the Costs part of the Idea Inspection.

Side by side

	Sole proprietorship	Single-member LLC
Forming it	Nothing to file; automatic when you sell on your own	Articles of organization filed with the state
Cost to start (October 2026)	$0, plus any DBA and local licenses	$40 in Kentucky, $70 in California, plus the same licenses
Yearly cost to the state	None for the structure	$15 a year in Kentucky; in California $20 every two years plus an $800 tax every year
Your personal assets	Liable for the business’s debts and lawsuits	Generally protected, except personal guarantees, your own wrongs and mixed money
Federal income tax, by default	Schedule C on your Form 1040	The same
Self-employment tax	Yes, once net earnings reach $400 a year	The same
Corporate or S corporation tax	Not available without forming a company	Available by election with the IRS
Paperwork each year	Your tax return	Your tax return, the state report and the company’s own records
Closing it	Stop trading	File to dissolve or cancel with the state

When to form an LLC, and when it can wait

Form one now if:

• you’re signing a lease, taking a loan or buying equipment on credit for the business (and read any personal guarantee before you sign);
• your work or your product could hurt a customer or damage their property: work in people’s homes, food, anything people put on their skin;
• you’re hiring, or bringing in contractors who act for you;
• you’re going into business with someone else, since two people trading together without registering are a general partnership by default, and each can be liable for the business’s debts;
• a client, landlord or supplier you need will only deal with a registered business.

It can usually wait if:

• you’re still finding out whether anyone will pay, since a filing fee and a yearly tax are poor spending on an idea that may not run (validate the idea first, then make it official);
• you’re working a few hours a week beside a job on low-risk work, such as writing, design or tutoring, with no debts, lease or staff (how to find time for a side hustle with a day job covers fitting it around the job);
• your state’s yearly cost is high against your sales, as in California, until the sales cover it comfortably.

Tip: whichever you choose, open a separate account for the business the day the first payment lands. For a sole proprietor it makes the books and the tax return simpler. For an LLC it’s part of what keeps the protection.

This is a general comparison, not legal or tax advice. Liability rules, fees and taxes vary by state, so if the business carries real risk, an hour with a small-business attorney or an accountant in your state costs less than getting it wrong.

Switching later

Starting as a sole proprietor doesn’t lock you in. Once the idea has proved itself, forming an LLC is the same filing it would have been on day one. Then move the business into it:

1. File the articles of organization with your state and write the operating agreement.
2. Get an EIN for the LLC if it needs one: employees, a bank that asks, or a state that requires it.
3. Open a bank account in the LLC’s name and run all the business’s money through it from that date.
4. Move contracts, licenses, payment accounts and the domain into the company’s name, and update your invoices and website.
5. Tell your bookkeeper or accountant the date. By default the taxes still go on Schedule C, but the records need a clean start.

Going the other way means dissolving or cancelling the LLC with the state, which has its own form and often a fee: Kentucky charges $40 for articles of dissolution. In California, the $800 tax keeps coming every year until the LLC is cancelled, so if you formed one too soon, cancel it rather than leave it idle, and ask an accountant about the timing. A change of structure can carry tax effects either way, so check with an accountant before you switch. The rest of the setup, from bank accounts to licenses, is in the Starting Up section.