The short answer: Taxes work nearly the same either way — both are pass-through by default, and both pay 15.3% self-employment tax on profits. The real difference is liability: an LLC separates your business debts from your personal assets (if you maintain it), a sole proprietorship doesn’t. An LLC costs money to form and maintain; a sole proprietorship costs nothing. Which one fits depends on your risk exposure and your revenue, not on marketing.
Taxes: closer than the ads make it sound
Here’s the part most formation-service ads won’t tell you clearly: an LLC and a sole proprietorship are taxed identically by default. A single-member LLC is treated by the IRS as a “disregarded entity.” Your business income and expenses go on Schedule C of your personal tax return, exactly like a sole proprietorship. There is no separate business tax return. Your income tax bill is the same either way.
Both also pay self-employment tax of 15.3% on profits — that’s 12.4% Social Security and 2.9% Medicare, applied to 92.35% of net earnings. (The 92.35% factor exists because employees effectively don’t pay SE tax on the employer’s half; it’s the IRS’s way of equalizing.) It applies whether you file as a sole proprietor or a single-member LLC.
The S-corp election: the real tax lever
The one genuine tax difference available to an LLC is electing to be taxed as an S corporation. As an S-corp owner, you pay yourself a reasonable salary (subject to payroll taxes, i.e., the same 15.3% Social Security/Medicare combined rate) and take the remaining profit as distributions, which are not subject to self-employment tax.
Rough rule of thumb: this starts to make sense once consistent profits are in the $40,000–$60,000+ range — below that, the added costs tend to eat the savings. Those costs are real:
- Payroll costs — running payroll, quarterly filings, unemployment insurance.
- A separate tax return — Form 1120-S every year, usually meaning a CPA engagement or upgraded tax software.
- Reasonable salary requirement — the IRS requires you to pay yourself a market-rate salary; you can’t take $0 salary and distribute everything.
There is no guaranteed “you’ll save $X” number. The savings depend on your profit level, what a reasonable salary is for your work in your market, and what payroll + tax prep costs in your area. If you’re considering it, talk to a CPA about your specific situation — this is genuinely one of those decisions where the advice pays for itself.
A sole proprietor can also form an LLC and elect S-corp taxation later — you don’t have to make this decision on day one. Many owners start as sole proprietors, form the LLC when revenue and risk justify it, and add the S-corp election in a later profitable year.
Liability: the actual distinction
This is where the two structures genuinely diverge.
Sole proprietorship: zero separation. You and the business are the same legal person. If the business owes money — an unpaid vendor, a broken contract, a lawsuit — creditors can come after your personal assets: your bank account, your car, your house. Your business debts are your debts.
LLC: separation, with conditions. A limited liability company is its own legal entity. If the business owes money, creditors generally can only reach the business’s assets — not your personal savings. But that protection is conditional, and this is where most small LLCs fail:
- Keep the veil intact. A separate business bank account is the minimum. Never pay personal bills from the business account or business bills from your personal account.
- Commingling pierces the veil. If you mix personal and business funds, a court can treat the LLC as a sham and hold you personally liable — at which point you paid LLC fees for protection you don’t have.
- An operating agreement matters. Even for a single-member LLC, it’s the document that defines the entity as separate from you. Banks often want to see one when opening the account.
What neither structure protects you from: your own negligence, professional malpractice, fraud, or personal guarantees. Sign a commercial lease or a business loan as a personal guarantor — which landlords and lenders routinely require from small businesses — and the LLC’s shield doesn’t cover that obligation. If you personally injure someone or personally do the negligent work, the LLC doesn’t shield you from that either.
So the honest framing: an LLC is a liability container. It works if you treat the container as real — separate money, separate records, signed agreements in the LLC’s name. It doesn’t make risk disappear.
Cost: the part people skip
A sole proprietorship costs $0 to create. You just start doing business. The only possible cost is a DBA (“doing business as”) filing if you operate under a name other than your own — roughly $25, though it varies by state and county (approximate; check locally).
An LLC costs real money, both to form and to maintain:
- Formation filing fee: $35–$520 depending on the state (as of October 2026 data: Montana is cheapest at $35; Massachusetts is most expensive at $520, which includes a $20 e-filing surcharge).
- Ongoing state costs: some states charge annual reports (Wyoming: $60/year), and some charge franchise taxes — California charges $800/year regardless of profit, Delaware charges $300/year. Texas charges neither. These recur every year you stay in business.
- Registered agent: $0 if you act as your own, or $125–$249/year for a commercial service ($175 is a reasonable midpoint for budgeting).
- EIN from the IRS: $0. Always free. Anyone charging you for an EIN is upselling.
For the full year-one breakdown across every cost layer, see How Much Does It Cost to Start an LLC.
Worked example: freelancer with $80,000 profit
Let’s make this concrete. You run a freelance business with $80,000 in net profit (after expenses). Income tax is identical either way, so we’ll compare only self-employment tax — and note that it’s also identical, because the default tax treatment is the same.
Self-employment tax math:
- Net earnings subject to SE tax: $80,000 × 0.9235 = $73,880
- SE tax: $73,880 × 15.3% = $11,303.64
So the answer: $11,303.64 in self-employment tax, whether you’re a sole proprietor or a single-member LLC. The LLC gives you zero tax savings at this profit level by default. If you elected S-corp taxation at this income, you might reduce the SE tax portion — but after payroll costs, a separate return, and a reasonable salary, the net savings need a CPA to verify for your situation. Don’t let an ad tell you it’s automatic.
The LLC’s value at this profit level is the liability separation — worth it if you have clients, contracts, or debts that could expose your personal assets.
Decision table
| Choose SOLE PROPRIETORSHIP if… | Choose an LLC if… |
|---|---|
| You’re testing an idea with little revenue | You sign contracts with clients, vendors, or landlords |
| You have no employees and minimal business debt | You want business debts separated from personal assets |
| Your personal asset exposure is low | You’re in a litigious industry (contracting, food, childcare, etc.) |
| You want $0 startup cost and zero paperwork | You want the option of S-corp taxation later |
| Your clients don’t require an entity to hire you | A bank, marketplace, or partner requires a business entity |
Either choice can change later. Starting as a sole proprietor and forming an LLC once revenue and risk justify it is a legitimate, common path — not a mistake.
If your question is now “which state should I form in,” read Best State to Form an LLC — and be skeptical of anyone telling you to form out of state when you operate in one. For state-by-state filing fees, see LLC Formation Cost by State.
Run your numbers through the LLC Formation Cost Calculator before you file — know the real year-one cost for your state
Methodology
- Fee data: 51-jurisdiction dataset compiled October 2026: TX ($300 filing, no annual report, no franchise tax), CA ($70 filing, $20 biennial report, $800/yr franchise tax), WY ($100 filing, $60/yr annual report, no franchise tax), DE ($110 filing, no LLC annual report, $300/yr franchise tax), MT ($35, cheapest), MA ($520 including $20 e-filing surcharge, most expensive). Registered agent range $125–$249/yr is commercial-service pricing observed in the market; $175 is used as a budgeting midpoint, not a quoted price.
- Tax figures: IRS self-employment tax rate (15.3%; 12.4% Social Security + 2.9% Medicare) and the 92.35% net-earnings factor are statutory and verified. The $80,000 example math was computed directly: 80,000 × 0.9235 = 73,880; 73,880 × 0.153 = 11,303.64. Income-tax equivalence between sole proprietorship and disregarded-entity LLC is per IRS treatment of single-member LLCs.
- S-corp discussion: The $40,000–$60,000 profit guideline is an industry rule of thumb, marked as such — not a statutory threshold. No specific savings figure is promised. Readers are directed to a CPA.
- DBA cost (~$25): approximate; varies by state and county. Publication costs and license costs referenced are ranges, marked approximate.
- What this is not: This guide is general information, not legal or tax advice. Entity choice affects your liability and taxes — talk to a CPA and/or attorney about your situation.
- Date-stamped: October 2026. State fees change; verify current fees with the Secretary of State before filing.
Frequently asked questions
Does an LLC save me money on taxes? Not by default. A single-member LLC is taxed exactly like a sole proprietorship — same pass-through treatment, same 15.3% self-employment tax on profits. The tax benefit only appears if you elect S-corp taxation, which makes sense at higher profit levels and adds payroll and filing costs.
Can I start as a sole proprietor and switch to an LLC later? Yes, and it’s common. Form the LLC when revenue, contracts, or risk exposure justify the cost. You can also elect S-corp taxation in a later year — none of these decisions are one-time-only.
Does an LLC protect my personal assets from everything? No. It separates business debts from personal assets only if you maintain the separation — separate bank account, no commingling, agreements in the LLC’s name. It doesn’t protect against your own negligence, fraud, or debts you personally guaranteed.
Is it worth forming an LLC in another state to save money? Usually no for an owner-operator. If you live and work in your home state, you’ll almost certainly need to register as a “foreign LLC” there anyway — paying two states’ fees instead of one. See Best State to Form an LLC for the full breakdown.
What’s the cheapest legitimate way to start? Sole proprietorship: $0. If you want the LLC, the floor is the state filing fee (as low as $35 in Montana as of October 2026), a free EIN from the IRS, acting as your own registered agent, and a free operating-agreement template. Skip the paid formation bundle — it doesn’t file anything you can’t file yourself.