Sole Proprietorship vs Single Member LLC
Are you a Maryland resident wanting to open a business? If so, Maryland offers a rich climate for business growth and development, leading the nation in entrepreneurial support and opportunity.
As you piece together your business framework, one of the first decisions you will make is your business structure. In Maryland, as in most states, the most popular business structures small business owners choose between are sole proprietorships vs. single-member LLCs.
While both are simple to establish, each entity has its own legal, financial, and tax implications. It’s wise to talk with an experienced Maryland business attorney about which is best suited to your business objectives and personal circumstances.
Meanwhile, to better understand sole proprietorships and single membership LLCs, let’s examine pros and cons of each.
Setting Up Your Business
Sole Proprietorships
Individuals, or married couples, starting a business are, by default, regarded as sole proprietors. The state makes no legal or tax distinction between the company and its owner. As such, sole proprietorships require no formal registration with the state unless operating under a fictitious name.
For instance, if the business’s name includes the owner’s first and last names, i.e., Jill Smith Cookie Company, there is no fictitious name. However, if the owner opts to exclude their first and last name, i.e., The Cookie Company, Maryland requires a fictitious name statement or DBA registration.
Single Member LLCs
Solo entrepreneurs who elect to conduct business as a single-member LLC are establishing a legal separation between themselves and the business. Therefore, an entrepreneur forming a limited liability corporation must formally register the LLC by filing their Articles of Organization with the state. When filing Articles of Organization, the LLC’s business name will automatically be registered, waiving the need for a fictitious name statement.
Although not required to be filed with the state, LLCs should also execute an Operating Agreement. This agreement further establishes the separation between business and owner, which may provide additional protection of personal finances and assets if a lawsuit occurs. And the document offers a solid platform for success by specifically outlining corporate procedures and policies. To learn more about the merits and structure of an operating agreement, consult your business attorney for advice.
Legal Protections and Personal Liability
Sole Proprietorships
There is no distinction between the business and the business owner under a sole proprietorship. Considered the same entity, there is no degree of legal separation between the two. The business owner is legally responsible for all debts and actions of the business. An owner's personal assets and property are vulnerable to debt collectors and lawsuits and may be levied as a form of debt repayment or restitution.
Single Member LLCs
An attractive feature of limited liability corporations is the legal separation afforded the owner from the business. As a legally recognized separate entity from the business, the owner’s liability for financial failings of the company is limited to owner’s investment in the LLC. Meaning, if the business becomes burdened by debt or lawsuits, the owner’s assets and wealth are protected from debt collectors and legal judgments provided the owner took no prior action to assume LLC liabilities such as executing a guaranty agreement.
It is important to note that unlike limited partners in limited partnership agreements, LLC owners do not lose their limited liability protections when actively participating in company management.
Tax Implications
Sole Proprietorships
State and federal tax agencies do not distinguish between the business and its owner under the sole proprietorship structure. The business is not considered a separate tax-paying entity, but rather its profit and losses translate through the owner's personal tax returns. The income of the business and the owner’s income are considered the same, and must be reported using an IRS Schedule C.
Business income is taxed at the individual’s income tax rate and is subject to Social Security and Medicare self-employment taxes. Organizing a tax payment plan with a qualified accountant is advised for sole proprietors. Because taxes are not withheld throughout the year, business owners should make quarterly estimated payments to the IRS for income and payroll taxes to avoid incurring large tax deficits and penalties.
Single Member LLCs
When establishing a single-member LLC, the business owner defaults to reporting business income on a Schedule C attached to his personal income tax return as though the business is a sole proprietorship. The LLC single member may separate his business tax obligations from his personal tax obligations by electing corporate tax treatment for the LLC.
Corporate tax treatment means the business income will be taxed as either a C Corporation or S Corporation. By choosing corporate tax treatment, the business owner can separate business profits from his business salary income which has advantages and disadvantages.
C Corporations file a separate business income tax return, and the owner/employee then files an individual return reflecting salary from the business and income received from the business profits (dividends). In this situation, the owner is treated as an employee and dividends are not taxed as employment income (avoiding the payment of employment taxes on business profits). While lessening the employment tax burden, the business owner will pay income tax on the business profits twice—at the corporate level when profits are earned and at the personal level when profits are received in the form of dividends.
Tax treatment as an S corporation passes all income tax obligations through to the owner’s personal returns. The S corporation must file annual income and quarterly payroll tax returns, and make periodic payroll tax payments, but the S corporation’s profits will not be subject to payroll taxes.
Tax reporting guidelines for C Corporations and S Corporations vary, as do the advantages of each. Communication with your business accountant and attorney regarding these options and the accompanying rules and procedures is highly recommended.
Protecting Your Maryland Business
Separation Of Finances
Whether you operate as a sole proprietor or single-member LLC, maintain separate business and personal financial records. Doing so will help you gauge an accurate picture of your company’s financial health and provide an opportunity for any necessary accounting or legal adjustments.
Maintaining separate funds is a requirement of LLC businesses and their members. Violating this rule by commingling funds could jeopardize the limited liability protections afforded by the LLC.
Ongoing Compliance
Business owners must know annual reporting requirements required by state agencies. Some annual filings that may affect sole proprietors and single-member LLCs include fictitious name statements, business permits, and licenses, Articles of Amendment, and Statements of Information.
Maryland requires all businesses to file an Annual Report and Personal Property Return with the Department of Assessment and Taxation by April 15th of each year. Both sole proprietors and single-member LLCs must comply with this requirement,” regardless of whether the business owns property, generates income or has conducted business activity in Maryland during the preceding year”.
Failure to adhere to state reporting requirements could cause a cancellation of your right to conduct business in Maryland. To avoid putting your company at risk, consult your Maryland business lawyer regarding compliance with essential filings.
Set Your Business Up for Success. Consult a Maryland Business Attorney Today.
No one ever starts a business with the idea of failing. However, owning and operating a small business is no easy endeavor. Understanding which business entity to choose for your business and personal situation is a critical first step toward success.
Call our office today to speak with a knowledgeable and experienced Maryland business attorney. With a thorough understanding of Maryland’s rules, regulations, and laws governing small businesses, we will work with you to establish a secure foundation for your company.
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