I’m Brittany Ratelle, an attorney for online business owners, just like you. I’m here to help you get legally legit and to help you show up as a more confident entrepreneur. We are going to walk through the differences between LLCs, DBAs, sole proprietorships, and a whole lot of other alphabet soup. How do I choose between Sole Proprietorship vs. LLC: Which one is the right choice for my online business? I am here to help you find the answers you need to know which entity structure will be the best fit for your business.
You hear a lot of confusing information online, in Facebook groups, from Google law school, or from so-called “business coaches,” advisors, and even accountants. I want to help you wade through all of that. I’m a licensed attorney and I’ve helped hundreds of business owners, just like you, with the kind of questions, direction, and guidance they need to make sure they’re choosing the right structure for their business now, so that they can be set up for success in the future.
Disclaimer: *While I am a licensed attorney and I practice in Utah and Idaho, I’m not your attorney and this is not official legal advice. If you have any questions, make sure you’re consulting with an attorney in your jurisdiction. I’m also not a tax professional or a CPA. If you have questions, make sure that you talk to a good accountant and a good attorney. They both should be in your corner as you develop your business.*
Why is this all so confusing?
LLCs, EINS, sole props, DBAs. There are a lot of acronyms out there. Can we tell that the government is involved, right? So, how are you supposed to know what is going to be the right fit for your business? It’s especially confusing if you have an online business. If you start to dig into the online resources, go into your local SBA office, or talk to your business banker, you might get some conflicting information. You also might get a whole lot of people who don’t understand or maybe even don’t think you are a “real business” and that you don’t have to worry about any of this right now.
I’m going to poke a few holes into that theory. If you don’t make any official business designation and just start making money, you are a sole proprietorship. There’s nothing “illegal” about that, per se. However, you’re missing out on some big advantages in terms of liability protection and tax benefits. We’ll dig into why that is and why an LLC might be just the right inexpensive, flexible entity structure for you as you grow from now to a million $ plus.
Who Needs an LLC?
What exactly is an LLC? Do you need one? LLC stands for limited liability company and they are set up at the state level. Each state keeps an online registry of LLCs. When it’s time to set up an LLC, you will go to your state office to do that. As I mentioned earlier, if you do nothing in your business, you are by default a sole proprietorship. Think of it as the Times New Roman font of a business entity. It’s what comes up, whether you do anything or not. The issue with this is that the IRS considers you a business if you’re making more than $600 a year. If you’re making less than that threshold, they basically call you a hobby and don’t monitor you as closely. But as soon as you make more than $600, you’re a business (surprise!) and they expect to see some sort of business activity in terms of income and expenses on your tax return.
Now, if you are an LLC, what’s surprising about this is that it actually does not change the way that you’re taxed. A lot of people think that there are tax consequences, which kind of throws them into an analysis paralysis of deciding. “What should I be? I don’t want to screw it up. I can’t move forward and I don’t want to do it wrong. And I don’t want to overpay in taxes.” And the simple answer here is that becoming an LLC doesn’t actually change the way that you’re taxed for good or for bad. What it does get you is liability protection.
This means that there is a fence between your personal money and your business money by setting up an LLC with your state. You’re basically saying, “Hello world! I am creating a new entity and this entity will be the one to solve your problems, make money, and provide goods or services. Not me. I work for the entity as an employee, a member, or a manager. However, I am not the entity. We have some separation here. In fact, we have so much separation that all of the money this business is going to make will go into the entity. All of the business expenses will flow out of that entity. And if you have a problem with that business, your problem is with the entity. Not me.”
What we want to do is have a nice firm boundary. We love boundaries. Boundaries are super sexy and they’re certainly sexy in business. By putting up this boundary or fence between ourselves and our business, we are making it so that if there is an issue in terms of liability, it’s a business problem. If someone sues the business or comes to collect a debt on the business that we can’t pay, the business will handle it. It’s not a personal problem.
This is especially important if you have personal money and a checking or savings account that you want to keep separate. It’s also important if you have money from a spouse’s business, their income, retirement funds, a home, vehicles, vacation home, or other investment properties.
If you have other assets and you want to have asset protection, meaning those things are not on the table if something goes wrong, the best way to put up that boundary is with an LLC (remember – limited liability company). It’s even in the name that we’re going to limit the liability. This protection is not 100% ironclad for all activities. There are ways to pierce the corporate veil if it could be shown that you are commingling money between your personal money and your business money.
Don’t make this common mistake!
One of the biggest mistakes I see people make when they set up their LLCs is that they go to Legal Zoom, Ink File, or some online business formation website. They throw money at someone (an attorney or an accountant) to help them set up an LLC. And they’re not given any more guidance on what to do next to make sure they keep that LLC protection in place.
And the number one way that people screw that up is they commingle their money. You don’t want to be commingling anything unless it’s on the dance floor. Make sure that after you set up your LLC, you keep your money separate from the get-go.
I’m going to walk you through the right order of operations to make sure that you’ve got that structure and you know what’s supposed to come first. Hopefully, I piqued your interest that an LLC might be the right vehicle for you. If you’re making more than $600, the IRS already thinks you’re a business.
What if I’m Losing Money?
Now you might be saying, “What if I’m not making money? What if actually I’m investing in the business and losing money? Don’t many companies operate at a loss and they’re still a real company?” Absolutely. In fact, if you think that you’re going to be in that camp (that you might be taking a loss in this business), there is something you can do. Show the IRS, “I’m not making any money, but I am doing business development things. I’m still a real business. I’m not trying to scam you.” You can prove this by forming an LLC because people usually don’t form LLCs unless they have the intent to make money eventually.
That’s their goal, because isn’t it great to make money in business? It should hopefully be on everyone’s to-do list. We want to make sure that all the income is coming into our LLC, and that all the expenses are coming out of the LLC.
Why Should I Choose an LLC?
You may need an LLC if you plan to hire an employee, deduct business expenses, sell a business, sell part of the business, invest in expensive equipment/software/vendor services, or enter into contracts. It’s also a good idea if you plan to have a business partner or partners come into the business and be equity partners with you. If you are interested in doing any of these activities, I highly recommend that you set up a limited liability company.
It’s what your colleagues, clients, and customers would expect for a sophisticated business at that level. It shows the world that you are interested in being treated as a real business and that you care about doing things right. It demonstrates that you’ve got your ducks in a row, and that you’re being intentional with your time, resources, and business plan.
Setting up an LLC says that you’re serious about how you want to show up and serve, not just today, but to have a lasting business with a sure foundation.
A limited liability company says all those things, and in most states, it’s the cheapest option to form that business structure. When I talk to business owners, do workshops, and do public speaking, I always get questions about this. “What about an S-Corp? What about a C-Corp or a B-Corp? I’ve heard about those. Let’s make sure you’re not leaving those on the table.” These are great questions.
An S-corp is actually not an entity structure. It is a tax designation that can bring in tax savings. There could be a point in your business where this would benefit you. Hopefully, you will hit it when you earn a reasonable salary from your business. Usually, when a business owner is making around $50,000, it becomes advantageous for people to make that switch.
And it actually means that you are changing your tax designation, or your tax election status, with the IRS. You’re saying, “Hey, IRS. I’m an LLC. I’d actually like to be taxed differently now because I think that’s going to save me some money.” It is something you definitely want to keep an eye on. I advise working with an account or another tax professional to make sure you’re doing it at the right time and that you’re following through with the next steps. It’s important that you’re setting up payroll and good bookkeeping so that you’re doing it right.
B-Corps vs. C-Corps
B-Corporations are C-Corporations that have a benefit purpose built into them. They’re not offered in all states yet, and it is something that could be a good hybrid choice if you have a social mission that’s part of the founding documents for your company. If you’re interested in this option, ask a local attorney or someone who’s working with you to see if it might be a good fit.
C-Corps are great, however, they have a couple more hoops to jump through and they’re a little more administratively taxing and burdensome for a company that’s just getting started. I usually don’t recommend this option unless you are looking to go public, get C-capital, and fundraise immediately, (or you think that that will happen in the next year or two). If you’re in that kind of startup trajectory, then it may be beneficial for you to skip the LLC and directly incorporate as a C-Corporation. Delaware is probably the most popular state in which to do that.
Which State Should I Use to Set Up My LLC?
If you are forming an LLC, please do not be swindled by online ads or people trying to sell you affiliate codes for programs or services. There is no “special state” where it’s better for you to set up your LLC. It’s not Delaware, Nevada, or Wyoming (unless you live there). It’s not better to do it through any of these companies that are just trying to make a buck off you. The best state to form your LLC is your state or your business partner’s home state. If you have multiple business partners, HINT: pick the one that has the least expensive filing fees and form your LLC there.
If you have more questions about this, make sure to download my free guide. This Legally Legit Workbook is going to walk you through the right steps to form your LLC.
How do I set up an online business?
Step #1: Set up a Business Address
The first step I advise business owners like you to do is set up a business address. I recommend a P.O. Box or a virtual business mailbox. Don’t use your home address. You will need an address to put in the footer on your website and emails. Also, you will need an address when you set up your LLC with your state.
Step #2: File an LLC with your state
Next, you will go to your Secretary of State website. You can easily find it by typing in LLC + your state, and look for the address ending in .gov. A bunch of ads will pop up trying to sell you their “easy” filing services. Don’t fall for it. You’re simply going to fill out the same forms that you want on your own. They’re trying to charge you extra and to upsell you on some stupid binder, rubber stamp, or EIN services (that’s free, by the way). You simply want to find where your state has you file LLCs.
If you land on a website that has some random government seal that you’ve never seen and it looks like it’s straight out of the late 1990s, you’re in the right spot!
If you’re on a really slick website with a cool user experience, that’s likely not a government website. That’s a third party trying to sell you something.
Go to the state website and fill out the form. You’re going to have to set up a username and password, go through their portal, and answer their questions. There are going to be a lot of questions about the business that you’re probably not involved with, so answer them the best that you can.
After you answer the questions, you will receive some founding documents, usually called articles of organization or a certificate of organization. It will have your state seal on it and will look nice, legit, and official.
Step #3: Get Your EIN/Tax Number From the IRS
The next step is to set up your EIN or your tax ID number. This is with the IRS and is online. It is free, but the business does have website hours (I know, SO WEIRD, right?). This is like your business social security number, and it’s going to get you set up for your business and allow them to track your payment details and allow you to fill out IRS forms properly in the name of your business entity. When accounting and money are flowing to your business, this will ensure that they are going to that business social security number or tax ID number, and not to you personally.
Step #4: Open a Business Bank Account
The fourth step is to open a business bank account in your new LLC’s name. Bring your articles of incorporation and EIN number with you to the bank. The business name should match on all the documents. You can give your business a simple, legal name, like Smith Holdings. There are plenty of people who do that and have a different name on their forward-facing business. If that’s the case, make sure you file a DBA (or Doing Business As), or a fictitious name filing.
However, if you already know the name of your business, go ahead and name that the same business as what the public will know it as. It will just make it a little bit cleaner, a little bit more clear, with less risk of chargebacks that way.
Step #5: Set Up a Business Credit Card
After you set up your business bank account, you can also open a business credit card. This is where you’ll charge all your company expenses. It can be attached to your business bank account. But be sure to keep this separate from your personal expenses.
Step #6: Use Your LLC
The next step is to actually use your LLC. This means that all the money you earn needs to go into that business bank account. It doesn’t matter if you’re selling products or services, selling in-person or online. Likewise, all of the expenses should go out of that bank account. You’re doing yourself a huge favor in setting up your business bookkeeping and your payment records. You should be using some way to track that business income and your profits and losses. A lot of people use software like QuickBooks, Zero, Wave, or Bench. You can even use old-school spreadsheets.
There there are pros and cons to each, but QuickBooks is a pretty industry-standard and easy-to-use software. If you decide to get support from an outside bookkeeper, accountant, or tax professional, they’re going to want you to use QuickBooks. It’s going to be easier for them to get you set up for success if they’re already familiar with the software you’re using.
Step #7: Don’t Commingle Money!
We talked about this earlier, but just remember to keep your personal accounts and business accounts separate. That means all of the business income should come into your business account – and all business expenses should be paid by that account (and whatever credit card or cards you link to it). The only place you should be “commingling assets” is on the dance floor – okay??!
Optional Step: Business Operating Agreement
If you have a business partner, or if you just want to have an extra layer of protection to make sure that the formalities are set up, I also recommend that you have a business operating agreement. These are also called business founder agreements, buy/sell agreements, or business partnership agreements.
An operating agreement is what governs an LLC. It will give information about how you’re going to get paid, and how to handle decision making. If there are partners, it will lay out how equity will be split up or what happens when someone leaves the company. These are some really important decisions that need to be made and put onto paper, because people can remember conversations differently. The best thing we can do is to have a fair contract. It’s nothing to fear and neither is a fair operating agreement. Your operating agreement is your business prenup.
We sign the business “prenup” on the front end, so we can avoid the ugly business divorce on the backend.
There’s no better time to start an LLC
I hope this has helped you decide whether it’s time for you to form an LLC. You might hear conflicting advice about LLCs, and it will take some time, money, and effort to set up. The reality is, though:
It will never be easier for you to form an LLC than when you are starting your business. The longer you wait, the harder it will be, and the more backtracking you’ll have to do.
You may have to redo payment processing and redraft contracts and vendor relationships. All of those documents should be in the name of your LLC. When you sign a contract, it should be in the name of your LLC. We want to make sure all of those things are set up as soon as possible in order to give us the most protection. I highly recommend that you set up a limited liability company as soon as you can. Please don’t delay on this.
Don’t get stuck or overwhelmed by some of these other companies that are going to try to get a piece of your money. This is something you can definitely handle on your own. However, there’s no shame in getting help and getting things done. If you know that you’re the type of person that’s going to feel overwhelmed and take too long to get this set up, you do have some other options. You can hire a local attorney to help you. Or you can pay for a third-party filing system like the ones that show up in Google searches. Just know that you’re paying a premium for someone else to fill out the same forms and answer the same questions. They’re not giving you some special access to your state LLC registration that you don’t have on your own.
Recap: Steps to start an LLC:
- Set up a business address
- File the LLC with your state
- Get your EIN/Tax ID number from the IRS
- Set up a bank account in the name of your LLC (Don’t forget to bring your LLC docs and EIN docs!)
- Open business credit cards
- Use your LLC – sign everything in your company’s name
- Don’t commingle money!!
If you like what you’re seeing here and want more information on how to be a legally legit business, make sure to leave a comment here or on my YouTube video. I’d love to hear from you about what you learned or what other questions you have about setting up your business. I hope this helped you understand the differences between sole proprietorship vs. LLC and which one is right for your online business.
You can also connect with me on Instagram. I’m like Ariel and I want to be where my creators, creatives, and online business owners are. Thanks so much for being here. Stay tuned for more when we dig into when you need to have a contract in your business and how can you make sure that you’re getting paid and getting paid on time.
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