Sole Proprietor vs. LLC: Which Structure Saves You More Money?
You just landed your first consulting client. Congratulations! But now you're facing a decision that could impact your taxes, liability, and paperwork for years to come: Should you operate as a sole proprietor or form an LLC?
The answer depends on your income level, risk tolerance, and long-term plans. Let's break down both structures so you can make an informed decision.
Legal Disclaimer
This article is for educational purposes only and not legal or tax advice. Consult a CPA, tax attorney, or business lawyer for advice specific to your situation.
Quick Comparison at a Glance
Sole Proprietor
Best for:
Low-risk consultants earning under $50K
LLC
Best for:
Consultants with liability risk or earning $50K+
Tax Differences: The Truth
Here's the most important thing to understand: An LLC taxed as a disregarded entity pays the EXACT same taxes as a sole proprietor. This shocks most new consultants who assume forming an LLC will magically reduce their tax bill. The IRS doesn't care what you call yourself—if you're a single-member LLC and don't elect special tax treatment, you're filing Schedule C and paying the same self-employment tax (15.3%), the same federal income tax, and the same state income tax as a sole proprietor.
The term "disregarded entity" means the IRS literally ignores your LLC structure for tax purposes and treats you as if the business doesn't exist separately from you. Same quarterly estimated payments, same deductions, same everything. The comparison charts below are identical because the tax obligations are identical. The only time an LLC can save you money is if you elect S-Corp taxation—but that election is available to both sole proprietors AND LLCs, so it's not an LLC-specific benefit.
Common Misconception
Many new consultants think forming an LLC will automatically save them on taxes. This isn't true.
By default, a single-member LLC is "disregarded" for tax purposes—meaning the IRS treats it exactly like a sole proprietorship.
Sole Proprietor Taxes
- • File Schedule C with personal return
- • Pay 15.3% self-employment tax
- • Pay federal income tax
- • Pay state income tax
- • Make quarterly estimated payments
Single-Member LLC (Default)
- • File Schedule C with personal return
- • Pay 15.3% self-employment tax
- • Pay federal income tax
- • Pay state income tax
- • Make quarterly estimated payments
↑ Notice something? They're identical.
When an LLC CAN Save Taxes
An LLC can save taxes only if you elect S-Corp taxation. But this is available to both sole proprietors AND LLCs.
Bottom line: The LLC structure itself doesn't save taxes. The S-Corp election does.
Liability Protection: The Real Difference
This is where the LLC shines. The primary benefit of an LLC is limited liability protection, and it's the real reason to form one. When you operate as a sole proprietor, you and your business are legally the same entity in the eyes of the law. If your business gets sued, creditors can come after your personal assets—your home, your savings account, your car, even your retirement accounts in some states. Your personal credit score is tied directly to business debts.
An LLC creates a legal separation between you and your business. The LLC is its own entity, which means in most cases, liability is limited to business assets. If your LLC gets sued or goes into debt, creditors generally can't touch your personal home, savings, or other assets. This protection isn't absolute—you can still be held personally liable for your own negligence or malpractice, which is why professional liability insurance (E&O insurance) is still critical. But for contract disputes, business debts, or third-party claims, the LLC shield protects everything you've built outside the business.
Sole Proprietor Risk
You and your business are legally the same entity. If your business gets sued or goes into debt:
- • Your home can be seized
- • Your personal savings can be taken
- • Your car can be repossessed
- • Your personal credit is affected
LLC Protection
The LLC is a separate legal entity. In most cases, liability is limited to business assets:
- Home is protected
- Personal savings protected
- Personal assets separate
- Only business assets at risk
Important Exception
LLCs don't protect you from liability due to your own negligence or malpractice. For example, if you make a critical error in your consulting work, you can still be held personally liable. This is why professional liability insurance (E&O insurance) is still important.
Cost Comparison: The Real Numbers
Sole Proprietor Costs
LLC Costs
LLC Costs by State (Examples)
California
$70 filing
$800/yr franchise tax
Delaware
$90 filing
$300/yr tax
Texas
$300 filing
$0/yr
Florida
$125 filing
$138.75/yr
When to Choose Each Structure
Choose Sole Proprietor If:
Sole proprietorship makes sense when you're just testing a side hustle or earning less than $30-50K annually. It's perfect for low-risk work like writing, graphic design, or coaching—services where the likelihood of being sued is minimal. If you already carry professional liability insurance (which covers malpractice), the urgency for LLC protection decreases further. The beauty of sole proprietorship is simplicity: zero setup costs, minimal paperwork, and you can start invoicing clients tomorrow.
The tradeoff is risk. If you're earning $20K on the side and have no significant assets, the personal liability exposure is manageable. But if you own a home with equity, have substantial savings, or are building wealth through investments, you're gambling that nothing goes wrong. For many early-stage consultants, that bet makes sense—use the $800 you'd spend on LLC fees for marketing instead and grow faster.
Choose LLC If:
Form an LLC once you're earning $50K+ annually or your work involves meaningful liability risk. If you're doing engineering consulting, giving financial advice, handling sensitive client data, or working with high-value contracts ($50K+ projects), the liability exposure becomes real. One lawsuit could wipe out everything you've built—your home equity, retirement accounts, investment portfolio. The $150-900 annual cost of an LLC is cheap insurance against catastrophic loss.
LLCs also make sense if you plan to grow. Want to hire employees eventually? An LLC provides cleaner structure. Working with enterprise clients or government contracts? Many prefer or require working with formal business entities. The professional image matters more than most consultants think—"John Smith Consulting LLC" signals permanence and seriousness in ways "John Smith" doesn't. Once you have significant personal assets to protect or you're generating meaningful revenue, the LLC becomes a no-brainer.
Decision Framework by Income Level
The decision becomes clearer when you map it to income level. Below $30K annually, the math favors simplicity—stay as a sole proprietor and invest the LLC fees in growing your business. Between $30K-50K, you're in the gray zone where personal risk tolerance and asset protection needs drive the decision. Above $50K, the liability exposure and professional credibility make an LLC worth the cost. Above $100K, you should not only have an LLC but also be exploring S-Corp taxation to reduce self-employment taxes.
$0 - $30,000/year
Sole ProprietorStay simple. Use that $800 for marketing instead of LLC fees. At this income level, you're building momentum—don't slow down with unnecessary complexity.
$30,000 - $50,000/year
Consider LLCDepends on your risk tolerance and whether you have assets to protect. If you own a home or have substantial savings, lean toward LLC. If you're renting and building wealth, you can wait.
$50,000 - $100,000/year
Form LLCThe liability protection is worth it at this income level. You're generating real revenue and likely have assets worth protecting. Make it official.
$100,000+/year
LLC + Consider S-CorpForm an LLC and talk to a CPA about S-Corp election. At six figures, the self-employment tax savings from S-Corp (typically $3,000-8,000 annually) more than pay for the additional accounting costs.
Ongoing Maintenance Requirements
Beyond the initial setup, both structures require ongoing maintenance—but the LLC adds a few extra layers. As a sole proprietor, you're looking at about 5 hours per year of compliance work: file Schedule C with your tax return, track business expenses throughout the year, keep records for at least 3 years, and make quarterly estimated tax payments. That's it. No annual filings, no state reports, no formal meetings.
An LLC requires everything above plus annual state filings (in most states), maintaining a completely separate business bank account to preserve liability protection, and potentially keeping meeting minutes if you have multiple members. Some states require updating your operating agreement when ownership or business activities change. Total time commitment increases to 8-10 hours per year, plus the annual fees ($0-800 depending on state). The difference isn't huge, but it's real—an LLC means you're committing to slightly more administrative overhead in exchange for legal protection.
Sole Proprietor
- • File Schedule C with tax return
- • Track business expenses
- • Keep business records 3+ years
- • Make quarterly tax payments
- Total time: ~5 hours/year
LLC
- • Everything sole proprietor does, plus:
- • File annual report with state
- • Maintain separate business bank account
- • Keep meeting minutes (if multi-member)
- • Update operating agreement as needed
- Total time: ~8-10 hours/year
Common Questions
Can I switch from sole proprietor to LLC later?
Yes! Many consultants start as sole proprietors and form an LLC once their income reaches $50-75K. This is a common and reasonable path.
Do I need a lawyer to form an LLC?
Not necessarily. Services like Northwest Registered Agent or LegalZoom can help you file for $200-300. However, if your situation is complex (multiple members, unique operating agreements), consult a business attorney.
Will clients take me more seriously with an LLC?
Sometimes. Enterprise clients and government contracts often prefer working with LLCs or corporations. For small business clients, it rarely matters.
What about S-Corp vs. LLC?
S-Corp is a tax election, not a legal structure. You can elect S-Corp taxation whether you're a sole proprietor or LLC. S-Corp makes sense when you're earning $80K+ and want to save on self-employment taxes.
Key Takeaways
The most important thing to understand: an LLC doesn't automatically save you taxes—it provides liability protection. By default, a single-member LLC pays identical taxes to a sole proprietor (15.3% self-employment tax + income tax). The tax benefits only appear if you elect S-Corp taxation, and that election is available whether you're a sole proprietor or LLC.
Start as a sole proprietor if you're earning under $30-50K annually. The simplicity and zero costs make it perfect for testing ideas and building momentum. Form an LLC once you hit $50K+ in revenue or accumulate significant personal assets worth protecting—at that point, the $150-900 annual cost is cheap insurance against catastrophic liability. Once you're generating $80-100K+, talk to a CPA about S-Corp election, which can save $3,000-8,000 annually in self-employment taxes.
Regardless of structure, get professional liability insurance (E&O insurance). An LLC protects against business debts and third-party claims, but it doesn't shield you from liability for your own negligence or malpractice. Insurance fills that gap and costs $500-2,000 per year depending on your field. Combined with the right business structure, you create comprehensive protection for both your business and personal wealth.