LLC vs Sole Proprietorship: Which Is Right for Your Business in 2026?

You're running a business on your own — freelancing, contracting, selling online or running a small shop — and wondering whether you should form an LLC or stay a sole proprietor. This guide compares the two on what actually differs: personal liability, taxes, self-employment tax, setup and yearly costs by state, and paperwork. It shows the tax math on a $80,000 profit, explains where BOI reporting stands after FinCEN's 2026 final rule, and ends with a simple test for when switching is worth it.

Quick answer

A sole proprietorship is you doing business with no filing and no separation from your personal assets. An LLC is a state-registered entity that shields your personal assets from business debts and claims. By default, a single-member LLC is taxed exactly like a sole proprietorship — same Schedule C, same self-employment tax — so the real trade-off is liability protection versus state fees and paperwork.

• Same federal tax by default: Schedule C plus 15.3% self-employment tax

• LLC formation costs $35 – $500 depending on the state, plus annual fees in most states

• Only an LLC (properly run) protects your house and savings from business debts

• US-formed LLCs no longer file BOI reports with FinCEN

• Switch when you have real liability exposure, contracts or employees — not to cut taxes

What each structure is

A sole proprietorship is the default. The moment you sell goods or services on your own without forming an entity, you are one. There's nothing to file with the state to create it, though you may still need a DBA for a brand name and local licenses. Legally, you and the business are the same person.

A limited liability company (LLC) is created by filing articles of organization (a certificate of formation in some states) with your Secretary of State. It's a separate legal person: it can own property, sign contracts and be sued in its own name. Its owners, called members, generally aren't personally liable for its debts.

LLC vs sole proprietorship at a glance

Side-by-side comparison (2026)

	Sole proprietorship	Single-member LLC
How it's created	Automatically when you start trading	File articles of organization with the state
Personal liability for business debts	Unlimited	Generally limited to what you put in
Federal income tax (default)	Schedule C on Form 1040	Schedule C on Form 1040 (disregarded entity)
Self-employment tax	15.3% on net earnings	15.3% on net earnings
Can elect S corp tax	No	Yes (Form 2553)
State formation fee	None (DBA fee if using a brand name)	$35 – $500
Annual state fees	Usually none	Often — e.g. $800 minimum tax in California
BOI report to FinCEN	No	No (if formed in the US)
Credibility with clients and banks	Lower	Higher

How it's created

Sole proprietorship

Automatically when you start trading

Single-member LLC

File articles of organization with the state

Personal liability for business debts

Sole proprietorship

Unlimited

Single-member LLC

Generally limited to what you put in

Federal income tax (default)

Sole proprietorship

Schedule C on Form 1040

Single-member LLC

Schedule C on Form 1040 (disregarded entity)

Self-employment tax

Sole proprietorship

15.3% on net earnings

Single-member LLC

15.3% on net earnings

Can elect S corp tax

Sole proprietorship

No

Single-member LLC

Yes (Form 2553)

State formation fee

Sole proprietorship

None (DBA fee if using a brand name)

Single-member LLC

$35 – $500

Annual state fees

Sole proprietorship

Usually none

Single-member LLC

Often — e.g. $800 minimum tax in California

BOI report to FinCEN

Sole proprietorship

No

Single-member LLC

No (if formed in the US)

Credibility with clients and banks

Sole proprietorship

Lower

Single-member LLC

Higher

Liability: the real difference

As a sole proprietor, the SBA puts it plainly: you can be held personally liable for the business's debts and obligations. If a client sues over a botched job, a supplier goes unpaid, or a lease is broken, the claim reaches your personal bank account, car and other assets, subject to your state's exemption laws.

An LLC puts a wall between the business and you. A judgment against the LLC is normally limited to the LLC's assets. That wall has gaps, though:

• Your own actions. If you personally cause an injury or commit fraud, you can be sued personally, LLC or not.
• Personal guarantees. Banks and landlords often require you to guarantee loans and leases personally, which bypasses the LLC.
• Piercing the veil. Courts can disregard the LLC when owners mix personal and business money, leave the company with too little capital to meet foreseeable obligations, or use it to commit fraud.

So an LLC only works if you run it like a separate business: its own bank account, its own contracts and invoices in the LLC's name, and no paying personal bills from business funds. Either way, buy general liability or professional liability insurance — an LLC doesn't replace it.

Taxes: identical by default

This is the part most people get wrong. The IRS treats a single-member LLC as a disregarded entity unless you elect otherwise. Its income and expenses go on Schedule C of your Form 1040 — the same form a sole proprietor uses — and you pay self-employment tax in the same way.

Here is the math for a business with $80,000 of net profit, whether it's a sole proprietorship or a single-member LLC:

The 15.3% rate is 6.2% × 2 for Social Security (on earnings up to $184,500 in 2026) plus 1.45% × 2 for Medicare. You owe it once net earnings reach $400. Both structures can also take the qualified business income deduction of up to 20% if eligible.

Try it — self-employment tax on your profit

Net Self-Employment Earnings

Taxable Base (92.35%)$73,880.00

Social Security (12.4%)$9,161.12

Medicare (2.9%)$2,142.52

Deductible Half$5,651.82

Self-Employment Tax$11,303.64

Open the full Federal Tax Calculator (PDF, save, compare)

A multi-member LLC is taxed as a partnership by default (Form 1065 plus a K-1 for each member). And any LLC can elect to be taxed as a corporation with Form 8832, or as an S corporation with Form 2553 — something a sole proprietorship can't do.

The S corporation option

The S corp election is where an LLC can cut taxes. You become an employee of your own company and pay yourself a salary that carries payroll taxes; remaining profit can come out as distributions without self-employment tax.

The IRS requires that salary to be reasonable for the work you do, and courts have rejected owners who took distributions instead of wages. Using the $80,000 example: a $50,000 salary carries about $7,650 in combined payroll tax (15.3%), versus roughly $11,300 as a sole proprietor — a saving near $3,650 before costs. Then subtract payroll service fees, a separate Form 1120-S return, accounting fees and any state-level S corp tax. At this profit level the net saving is often small; at $150,000 it's usually more meaningful. Have a CPA model it before electing.

Formation and yearly costs by state

A sole proprietorship costs nothing to form. An LLC costs a state filing fee up front and, in most states, a yearly report fee or tax. Using our verified fee data:

LLC first-year state costs (examples, 2026)

State	Formation fee	Ongoing yearly cost
Montana	$35	Annual report fee
Delaware	$110	$400 annual tax, due June 1 (for the prior year)
Florida	$125	$138.75 annual report
New York	$200	Publication: $50 certificate plus newspaper costs (one time)
Texas	$300	No franchise tax due at or below $2.65 million revenue; information report still required
California	$70	$800 minimum annual tax
Massachusetts	$500	$500 annual report

Montana

Formation fee

$35

Ongoing yearly cost

Annual report fee

Delaware

Formation fee

$110

Ongoing yearly cost

$400 annual tax, due June 1 (for the prior year)

Florida

Formation fee

$125

Ongoing yearly cost

$138.75 annual report

New York

Formation fee

$200

Ongoing yearly cost

Publication: $50 certificate plus newspaper costs (one time)

Texas

Formation fee

$300

Ongoing yearly cost

No franchise tax due at or below $2.65 million revenue; information report still required

California

Formation fee

$70

Ongoing yearly cost

$800 minimum annual tax

Massachusetts

Formation fee

$500

Ongoing yearly cost

$500 annual report

Worked example — California freelancer. Forming an LLC costs $70, then the $800 minimum tax every year whether or not you make a profit. Over three years that's about $2,470 in state charges a sole proprietor wouldn't pay. In Texas, the same freelancer pays $300 once and, below the franchise tax threshold, no franchise tax — just the yearly information report.

Our LLC registration guide has the step-by-step filing process and more states.

BOI reporting in 2026: not required for US LLCs

When the Corporate Transparency Act took effect, LLCs had to report their owners to FinCEN. That's no longer the case for domestic companies. FinCEN's interim final rule of March 26, 2025 limited reporting to companies formed under foreign law, and the final rule announced in August 2026 made the exemption for US-formed companies permanent.

If you formed your LLC in any US state, you don't file a beneficial ownership report. Ignore letters and emails demanding a BOI filing fee — these are commonly scams. Sole proprietorships were never covered.

When to switch from sole proprietor to LLC

A quick decision test

Step 1

Could a customer, worker or contract claim exceed your insurance?

Step 2

Yes → form an LLC

and keep insurance

Step 3

Hiring employees or signing a lease?

Step 4

Yes → form an LLC

before you sign

Step 5

Profit high enough for an S corp election?

Step 6

Yes → LLC + talk to a CPA

Step 7

None of these → sole prop is fine

revisit yearly

Signals it's time to form an LLC:

• You work in clients' homes, handle their money or data, or give advice they rely on
• You're about to sign a commercial lease, equipment loan or large contract
• You plan to hire your first employee
• Clients or platforms ask for a business entity before they'll contract with you
• You own a home or significant savings you want to keep separate
• You expect enough profit that an S corporation election could save money

Staying a sole proprietor is reasonable when the business is a low-risk side hustle, profit is modest and you live in a state with high LLC fees — for example, a part-time tutor in California, where the $800 yearly tax may outweigh the benefit.

How to switch: step by step

1. Check the name is available and form the LLC with your Secretary of State
2. Sign an operating agreement, even as a single member
3. Get an EIN for the LLC — required once it has employees or owes excise taxes, and most banks want one
4. Open a business bank account in the LLC's name
5. Move assets, contracts, domain names and leases into the LLC
6. Update licenses, permits, sales tax registration and your DBA
7. Tell clients to pay the LLC and update invoices and W-9s
8. Keep sole proprietorship records for the part of the year before the switch

The IRS says a sole proprietor doesn't need a new EIN just to change a business name or location, but a single-member LLC needs its own EIN once it has employees or excise tax obligations. Our EIN application guide covers the free IRS process, and you can set up LLC-branded invoices with the invoice generator.

Official resources

• SBA — Choose a business structureOverview of every structure
• IRS — Single member LLCsDefault tax treatment and EIN rules
• IRS — Self-employment taxRates and thresholds
• IRS — S corporation compensationReasonable salary rules
• FinCEN — Beneficial ownership informationCurrent BOI rules
• California FTB — LLC tax$800 annual tax and LLC fee

What to do next

If you're staying a sole proprietor, register a DBA for your brand name, open a separate bank account and buy insurance. If you're ready for an LLC, check your name with the LLC name checker and follow the LLC registration guide. Either way, plan for self-employment tax with our business tax filing guide.

This is general information, not legal or tax advice — confirm on the official source or with a professional.

Frequently asked questions

Do LLCs pay more tax than sole proprietorships?

Not by default. A single-member LLC is a disregarded entity for federal income tax, so its profit goes on Schedule C of the owner's Form 1040 exactly like a sole proprietorship's, with the same 15.3% self-employment tax. The difference is state-level: some states charge LLCs annual taxes or fees, such as California's $800 minimum, that sole proprietors don't pay.

Is a sole proprietor personally liable for business debts?

Yes. A sole proprietorship isn't a separate legal entity, so business debts, contracts and lawsuits are your personal obligations. A creditor or a customer who wins a judgment can pursue your bank accounts, car and, subject to state exemptions, your home. Business insurance covers some risks, but not unpaid debts or claims your policy excludes.

Does an LLC protect me if I make a mistake?

Only partly. An LLC protects you from the company's debts and from claims against the business, but not from your own negligence or wrongdoing — if you personally injure someone, you can still be sued personally. You also lose protection if you mix personal and business money or sign loans with a personal guarantee. Insurance remains essential with or without an LLC.

Can I convert my sole proprietorship to an LLC?

Yes. You form a new LLC with your state, then move the business into it: open a new bank account, retitle assets and contracts, update licenses and tell customers to pay the LLC. A single-member LLC with no employees can generally keep reporting on Schedule C. You'll need an EIN for the LLC once it has employees or owes excise taxes.

Does my LLC need to file a BOI report in 2026?

No, if it was formed in the United States. FinCEN's interim final rule of March 26, 2025 removed the requirement for domestic companies, and its final rule announced in August 2026 made the exemption permanent. Only companies formed under foreign law and registered to do business in a US state still report.

When does an S corporation election make sense?

Usually only once profit is high enough that payroll savings beat the extra costs. An LLC taxed as an S corporation must pay you a reasonable salary subject to payroll taxes; only the profit above that escapes self-employment tax. Add payroll service fees, a separate corporate return and possible state taxes, and many owners find it pays only well into five-figure profits. Ask a CPA to run your numbers.

Sources & verification

Figures on this page were checked against the sources below when it was last reviewed on 7 October 2026. Each rate and limit is stored once with its own official source and review date, and official update channels are monitored daily so changes are picked up. How we verify

1. 1.Choose a business structure — U.S. Small Business Administration · accessed 7 October 2026
2. 2.Single member limited liability companies — IRS · accessed 7 October 2026
3. 3.Do you need a new EIN? — IRS · accessed 7 October 2026
4. 4.Self-employment tax (Social Security and Medicare taxes) — IRS · accessed 7 October 2026
5. 5.S corporation employees, shareholders and corporate officers — IRS · accessed 7 October 2026
6. 6.Beneficial Ownership Information Reporting — FinCEN · accessed 7 October 2026
7. 7.Limited liability company (LLC) — California Franchise Tax Board · accessed 7 October 2026
8. 8.Piercing the corporate veil — Cornell Law School Legal Information Institute · accessed 7 October 2026