Sole Proprietor vs LLC: Tax Differences
Quick Answer
A single-member LLC and a sole proprietorship are taxed exactly the same way by default — both file Schedule C and pay 15.3% self-employment tax on net profit. The main difference is liability protection: an LLC separates your personal assets from business debts, while a sole proprietorship does not. The real tax benefit comes if you elect S-Corp treatment for your LLC, which can reduce self-employment tax.
Tax Comparison
| Feature | Sole Proprietor | Single-Member LLC | LLC with S-Corp Election |
|---|---|---|---|
| Tax form | Schedule C | Schedule C | Form 1120-S |
| Self-employment tax | 15.3% on all net profit | 15.3% on all net profit | Only on salary portion |
| Liability protection | None | Yes | Yes |
| Complexity | Lowest | Low | Moderate |
| Filing cost | None | $50-$500/year (state) | $500-$1,500+ (payroll + CPA) |
Real Example With Actual Numbers
Carlos is a freelance software developer in Texas earning $120,000 in net profit after business expenses.
As Sole Proprietor
| Tax | Amount |
|---|---|
| SE tax (15.3% on $110,820) | $16,955 |
| Federal income tax (after SE deduction) | ~$14,200 |
| Total | ~$31,155 |
As Single-Member LLC (Default)
Identical to sole proprietor. The LLC provides liability protection but zero tax difference.
| Tax | Amount |
|---|---|
| SE tax | $16,955 |
| Federal income tax | ~$14,200 |
| Total | ~$31,155 |
As LLC with S-Corp Election (Salary: $75,000 + Distribution: $45,000)
| Tax | Amount |
|---|---|
| Payroll tax on salary (15.3% on $75,000) | $11,475 |
| Federal income tax on full $120,000 | ~$15,000 |
| Total | ~$26,475 |
| Payroll/CPA costs | ~$2,000 |
| Net total | ~$28,475 |
S-Corp election saves Carlos ~$2,680/year after accounting for extra filing costs. Try the freelance calculator to see your own comparison.
When Each Structure Makes Sense
Stay as Sole Proprietor If:
- You are just starting out or testing a business idea
- Net profit is under $30,000
- You want zero paperwork and filing costs
- You are comfortable with personal liability risk
Form an LLC (Default Taxation) If:
- You want to protect personal assets from business lawsuits
- Clients or contracts require an LLC
- Net profit is $30,000-$70,000 (not enough for S-Corp to make sense)
- You want a more professional business image
Form an LLC with S-Corp Election If:
- Net profit consistently exceeds $70,000+
- The SE tax savings exceed the extra costs ($2,000-$3,000/year for payroll and CPA)
- You can justify a reasonable salary
- You are willing to run payroll
State-Specific Considerations
LLC costs and requirements vary by state:
| State | Annual LLC Fee | Notes |
|---|---|---|
| California | $800 minimum franchise tax | Even if LLC earns nothing |
| Texas | $0 (no franchise tax under threshold) | Very LLC-friendly |
| Florida | $138.75/year | Annual report required |
| New York | $25 + publication requirement ($1,000-$2,000) | Expensive to form |
| Wyoming | $60/year | Popular for out-of-state LLCs |
California's $800 minimum tax makes forming an LLC less attractive for low-revenue businesses.
The Liability Protection Advantage
Even without tax benefits, an LLC provides a crucial shield:
- Without LLC: If a client sues your business, they can go after your personal bank accounts, home, and car
- With LLC: Liability is limited to business assets (assuming you maintain proper separation between personal and business finances)
This protection alone makes an LLC worthwhile for most freelancers once they have significant income or client exposure.
Steps to Form an LLC
- Choose your state and file Articles of Organization ($50-$500)
- Get an EIN from the IRS (free)
- Open a separate business bank account
- Decide whether to elect S-Corp tax treatment (file Form 2553 with the IRS)
- If S-Corp, set up payroll for your salary
- Continue tracking expenses for Schedule C or 1120-S
Estimate your taxes under any structure at the freelance calculator or check your independent contractor tax obligations.