LLC vs Sole Proprietor: Which is Better for Tax Savings?

In the United States, in the year 2025, about 34.8 million small businesses are operating, and impressively, these small businesses constitute more than 90% of all businesses in the country and provide almost half of the employment opportunities in the private sector. Amongst the various types of business structures to choose from, sole proprietorship and limited liability company (LLC) are the most commonly selected types, with over 834,000 sole proprietorships currently in existence throughout the U.S. However, many business owners question themselves on a very critical matter: Which will earn them more tax savings: LLC or Sole Proprietorship? 

This comprehensive blog is meant to guide you through a detailed evaluation of the tax implications, pros, and cons that come with either structure to allow you an informed decision best suited for your business needs.

What is a Sole Proprietorship?

In the United States, a sole proprietorship is among the simplest and most common types of business organizations. An unincorporated business used by an individual is considered a sole proprietorship. In essence, no legal separate difference or distinction exists between the business and its owner where the former type of business is set up. A good thing about setting up a sole proprietorship is that one does not have to file any special forms or documents just to be recognized as a sole proprietor: simply open a business in your name.

Key Features:

Below are some of the features of a sole proprietorship:

• Easy to install and inexpensive in startup and maintenance fees.
• Total control by the owner.
• There is no distinct separation or separation between business assets and personal assets.
• Profits of corporations are reflected on the owner's tax return.

What is an LLC (Limited Liability Company)?

An LLC is a legal entity at the state level that keeps the business liabilities from affecting your assets. This entity can have only a single owner (member) or it can have several, and it gives more flexibility as to how the taxes of the business are treated. 

Key Features:

Let us understand the advantages of an LLC:

• Liability protection for owners (personal assets are generally shielded).
• Adaptable organizational design.
• Can decide how they are taxed (default pass-through, S corp, or C corp).
• Greater levels of customer and business partner credibility alike.

Taxation: LLC vs Sole Proprietor

Both sole proprietors and LLCs typically use pass-through taxation, meaning business profits are reported on the owner's tax return; however, LLCs offer more tax flexibility, allowing owners to elect corporate tax treatment (such as S corp or C corp), which can provide additional tax planning opportunities and potential savings.

Taxing a Sole Proprietorship

• Pass-through Taxation: Whatever your business makes is directly passed through to your tax return on Schedule C of Form 1040.
• Self-Employment Tax: As you are self-employed, you must also file for and pay self-employment taxes. These taxes amount to 15.3% of your net business income for Social Security and Medicare contributions.
• Limited Deductions: Business expenses that are ordinary and necessary in carrying on a business are generally deductible for tax purposes; however, some deductions are limited, for example, some retirement contributions or health insurance premiums may be more restricted than those that would generally be deductible by an LLC.

LLC Taxation

• Default Pass-Through Taxation: Taxation of a single-member LLC is by default that of a sole proprietor, while a multi-member LLC is automatically taxed as a partnership.
• Flexibility of Tax: An LLC can elect to be taxed either as an S or C-corporation. Such a tactical election can open up opportunities for additional tax savings that may not otherwise be available.
• Self-Employment Tax: Generally, because their earnings are considered self-employment income, LLC owners pay self-employment tax; yet, under an S corp status, owners may pay themselves a reasonable salary and treat additional profits as distributions, which are not subject to self-employment tax.
• Furthers Deductions: An LLC may be eligible for other business deductions such as health insurance, retirement plans, and certain fringe benefits.
• State Taxes: Some states impose additional taxes or charges on LLCs, such as franchise taxes, that are not imposed on sole proprietors.

Tax Savings: LLC vs Sole Proprietor

Key Note

Although it is true that both types of structures inherently provide pass-through taxation as the default, an LLC uniquely has the option to elect to be an S corporation or a C corporation, and this can be a huge tax saver for businesses that are generating a lot of income.

Other Factors to Consider

Here are some of the overlooked factors to consider to understand the difference between the taxation of a sole proprietorship and an LLC:

Liability Protection

• Sole Proprietorship: There is no separation or distinction between your personal property and your business property; therefore, you are personally liable for any business debt and any lawsuit brought against the business.
• LLC: Personal property tends to be exempt from business debt, providing a sense of protection and legitimacy.

Administrative Complexity

• Sole Proprietor: Easiest to establish and keep running, with fewer documents and lower expenses.
• LLC: Need to be registered with the state, need yearly filings, and may entail greater upfront and ongoing fees.

Credibility and Growth

• LLC: An LLC, or Limited Liability Company, is generally considered more respectable by consumers, creditors, and investors. This added respectability makes it easier to find partners or secure financing for business purposes.
• Sole Proprietor: This individual may encounter many difficulties when expanding their business operations or being in a position to attract investment from external sources effectively.

Statistics Concerning Small Businesses in the United States in 2025

Here is some statistical information on different types of small businesses in the USA in 2025: 

• Total small firms: 34.8 million, 99.9% of all U.S. firms
• Sole proprietorships: 834,711, around 10.24% of all firms
• LLCs: Increasing steadily, popular for liability protection and tax convenience

When Does an LLC Make Sense for Tax Savings? 

Here are some key points that may help you determine if the LLC is a better option for tax savings:

• Your business is generating ample profits successfully, which are typically well above $40,000 in net profit or more.
• If you want to minimize your self-employment tax obligations, one way to do this is by electing an S corporation.
• You intend to reinvest earnings or take on partners.
• You wish to have maximum deductions of medical insurance, pension, and extra benefits.

When is Sole Proprietorship Your Best Option?

You must be aware of these points if you want to take sole proprietorship as your business option:

• Your business could already be operating as a side business, or could be generating relatively tiny profits today.
• You wish to make the simplest and lowest-cost installation.
• You don't concern yourself with liability protection.
• You do not have any employees or partners.

Also Read | Is Drake Good for Bookkeeping Firms Expanding into Tax Prep?

Conclusion

For the vast majority of those starting as a new business owner, starting as a sole proprietor is typically the easiest and lowest-cost option to pursue. But as your business grows and becomes more profitable, forming a limited liability company, specifically one tax-treated as an S corporation, can uncover significant tax savings opportunities. It can also give you valuable liability protection. It is always best to consult a tax advisor like The Fino Partners to carefully examine your circumstances and to help ensure you are taking advantage of all available tax benefits and determine what to choose: LLC or Sole Proprietorship?