This is the next post in our series on starting an Oklahoma business with confidence.  The previous article discussed the annual renewal requirements for an Oklahoma LLC and ways to keep your entity active with the Oklahoma Secretary of State.  This article focuses on an often-recurring question: what is the difference between an LLC and a Sole Proprietorship?

Whether you finally leaped to start your dream business or are expanding an existing one, the question remains – what entity type to select?  For legal assistance in entity selection, entity formation, organizational document drafts, or related services, get in touch with Niroula Law today.  You can contact us online or by telephone to reach out and speak to an OKC business lawyer.

Deciding to venture into a new endeavor is only the first step, the immediate next is entity selection.

Legally speaking, this is one of the most crucial steps in the life of a new business. Entity choice has a direct impact on your business, including financial, tax, legal, and liability considerations. The most common entity types include (1) limited liability company (LLC), (2) sole proprietorship, (3) general partnership, (4) limited partnership, and (5) corporation – “C” and “S”.  

Your selection must align with the specific needs of your business, offer optimal flexibility, and minimum liability exposure, and be compatible with the specific industry. The ultimate decision in entity selection rests with you. Nevertheless, we aim to provide insights into various entities to help clarify some of the burning questions – so you can make the right choice.

What is an Oklahoma LLC?

An Oklahoma Limited Liability Company (LLC) is a business structure formed under Oklahoma statute 18 O.S. §2000.  It is also referred to as a “hybrid” entity because it has some of the characteristics of a general partnership and some characteristics of a corporation.  As a result, an LLC offers its owners the benefit of a limited liability akin to a corporation and reduced formalities akin to a general partnership.

The formation and operation of an LLC is governed by the Oklahoma Limited Liability Company Act.  It is formed by filing an article of organizations with the Oklahoma Secretary of State.  Except for some of the rules, such as formation, much of its provisions can be modified or replaced by an article of organization or an operating agreement.  An operating agreement is not a requirement but is highly recommended.

The owners of an LLC are called members and membership shares are called units.  For instance, a single (sole) owner is said to own 100% of its units or all membership units.  

An LLC is not subject to an Oklahoma corporate franchise tax and is treated as a pass-through entity for income tax purposes.  As a result, the LLC’s profits and losses pass through to the owner’s individual tax returns.  LLC does not pay its own taxes.  It’s paid only once by its owners in their individual tax returns – thereby avoiding double taxation unless the LLC elects to be taxed as a C-corp.  Then, it will be taxed at both the levels. 

What is an Oklahoma Sole Proprietorship?

Oklahoma sole proprietorship has no formal filing requirements for its formation or existence.  For instance, if Mary has been selling hand-made custom hats from her garage, then she has likely formed a sole proprietorship.  For this reason, a sole proprietorship is the simplest structure that you can start a business with.  As the name suggests, this entity can have only one owner, the sole proprietor herself.  

The owner can hire employees to perform work on behalf of the company, borrow funds, purchase real property, or rent equipment like any other business.  Similarly, if she must obtain licenses or permits for a specific trade or occupation, then she must do so.  If you are planning on hiring, you need to acquire an EIN.  It is a permanent number issued by the IRS that can also be used for opening a bank account, applying for business licenses, and filing tax returns.

Just like an LLC, a sole proprietorship is a also pass-through entity.  It is not subject to the corporate income tax, and any business income passes to and is considered the owner’s income filed in her personal tax return.  Similarly, all business losses are her personal responsibility.  One of the most important disadvantages of this business structure is its unlimited personal liability.  Sole proprietors are legally responsible for all debts against the business, putting their business and personal assets at risk.

What are the differences between an Oklahoma LLC and Sole Proprietorship?

When starting a new business, you are faced with the challenge of selecting the proper business entity.  You may be wondering whether you should form an LLC or conduct business without filing any paperwork with the Secretary of State, as a sole proprietorship.  Before you make that decision it’s crucial to know the differences between the two.

A sole proprietorship is the simplest form of business entity, while an LLC requires some initial paperwork.  The most common difference lies in the nuances of business formation.  For instance, a sole proprietorship is the default model for someone who is running a business but hasn’t formally set up an entity yet.  However, the most important difference lies in the burden of liability.

An LLC member is not liable for the business’s obligations or debts.  For this reason, an LLC’s creditor is unable to come after your personal assets.  On the other hand, a sole proprietorship does not create a separate business entity.  This means that your personal assets and liabilities are not separate from your business assets and liabilities.  Your personal assets are left vulnerable to debts and obligations of the business.

Should I set up my business as an LLC or a Sole Proprietorship?

Choosing the right entity is crucial for the optimal functioning of a business, and the entity you select ultimately rests on your needs.  But there are a few things that you should consider before going with one or the other.

  • Liability Protection: As a sole proprietor, there is no legal distinction between you and your business – your personal assets are at risk. With an LLC, your personal assets are generally protected from business liability.
  • Tax Implications: Income from a sole proprietorship passes through to the owner and is reported in the owner’s individual tax return. An LLC is a pass-through entity by default. However, it does offer flexibility on how you want to be taxed. It can elect to be taxed as an S-Corp, providing potential tax advantages. 
  • Ease of Formation and Maintenance: A sole proprietorship is easy to form and requires minimal paperwork. LLC requires more paperwork and filing fees. It also has ongoing compliance requirements, such as annual certificate filings.
  • Flexibility in Management: A sole proprietor has sole control over management and operations. On the other hand, an LLC allows the members to manage the business themselves or hire managers, providing a more flexible approach to organizational structure.

OKC business lawyer: serving all Oklahomans

Niroula Law is a business law firm that deals with entity formation, document drafting, and various compliance requirements.  If you are seeking legal counsel for matters related to LLC or any other business concerns, our dedicated team is here to assist you.  Contact us online or by phone to get in touch with an OKC business law firm and speak to an Oklahoma business attorney.  We serve Oklahoma County, Logan County, and Cleveland County.