Self-Employed vs. LLC: Taxes, Liability, Costs (2025)

Choosing the right business structure is one of the most consequential decisions that a small business owner or freelancer can make. Whether you operate as a self-employed sole proprietor or form a limited liability company (LLC), your choice impacts virtually everything in your business, including: 

• How you pay taxes

• Your personal liability protection

• Ongoing administrative costs

Weighing the merits of operating as a sole proprietorship vs. an LLC is a little easier with this essential guide. Use it to understand the differences of each entity and for an outline of their pros and cons, so you can determine which path is the optimal fit for your business stage, risk profile, and financial goals.

Key Highlights

• A sole proprietorship is the simplest way to operate, but it offers no personal liability protection.

• An LLC provides a legal shield for your personal assets—if you follow compliance rules.

• Both structures face self-employment tax obligations unless the LLC elects S corp status.

• State filing fees and annual compliance costs vary widely, from $35 to $800+.

• The optimal choice depends on your profit level, risk exposure, and client expectations.

• S corp elections can save on self-employment taxes, but come with payroll and admin requirements that you can avoid with other entities. 

Self-Employed vs. LLC – What’s the Difference?

Definitions (Legal vs. Tax Status)

When a freelancer, gig worker, or independent contractor says they're “self-employed,” they typically mean they operate as a sole proprietorship—an unincorporated business owned by one person, with no separate legal entity.

An LLC, on the other hand, is a legal business entity formed at the state level. By default, a single-member LLC is taxed like a sole proprietorship, while a multi-member LLC is taxed as a partnership. Both can elect corporate taxation, including S corp status, to harness potential tax benefits.

When Each Option Fits

Review each option, considering who benefits the most when operating as either business entity type. 

Sole proprietorships are ideal for workers who wish to avoid extensive paperwork and formalities, including: 

• Low-risk freelancers

• Solo consultants

• Side hustlers

LLCs are common for growing businesses seeking credibility with clients and vendors, and who need to:  

• Sign contracts

• Hire employees

Liability & Risk

Sole Proprietor Exposure

As a sole proprietor, you and your business are legally the same. This is great for workers who value simplicity, as long as they stay out of trouble. If your business is sued or owes money, your personal assets could be at risk, including your: 

• Bank account 

• Home

• Vehicle

Business insurance can help, but it doesn't provide the complete personal liability protection enjoyed by LLCs and other business entities. 

LLC Protections (and How to Keep Them)

Forming your business as an LLC creates a legal barrier between your personal and business assets, which is a popular feature. This protection is most effective if you:

• Keep business and personal finances separate.

• Maintain an operating agreement.

• Use a registered agent.

• Avoid “commingling” funds to reduce the risk of piercing the corporate veil.

Even with an LLC, insurance is still necessary. It adds an extra layer of protection that the legal structure alone can’t provide.

Taxes & Elections

Default Taxation & Self-Employment Tax

Both sole proprietors and single-member LLCs report business income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), and pay self-employment tax—15.3% of net earnings (12.4% Social Security up to the wage base, plus 2.9% Medicare). The 2025 Social Security wage base is $176,100.

Multi-member LLCs file IRS Form 1065, U.S. Return of Partnership Income, and issue a Schedule K-1 to each owner for reporting their share of income on their personal income tax returns. 

LLC Taxed as S Corp (When It Helps)

An LLC can elect S corp status to potentially reduce self-employment tax. Owners must pay themselves a reasonable salary (subject to payroll taxes) and take remaining profits as distributions, which are not subject to self-employment tax.

This strategy can save money once your profits reach a steady mid-five-figure range or higher—but it adds payroll obligations and administrative work.

QBI Deduction Timing

Both sole proprietors and pass-through LLCs may qualify for the Qualified Business Income (QBI) deduction—up to 20% of qualified income. The deduction was set to expire after 2025, until it was made permanent via the Big Beautiful Bill, among other changes, business owners and self-employed individuals should know about.  

Costs & Compliance

Formation & State Fees

LLC formation fees vary by state—from $35 to over $500, with a national average of around $132. Some states also charge annual franchise taxes, like California’s $800 minimum tax.

The time and paperwork can be overwhelming without 1-800Accountant's entity formation service, starting at $0 + state fees, working on your behalf.    

Ongoing Admin

Both structures require basic bookkeeping and quarterly estimated tax calculations and submissions. While sole proprietors have fewer responsibilities, LLCs also face:

• Annual state filings.

• Registered agent fees.

• Payroll filings, if taxed as an S corp.

• Careful recordkeeping to maintain liability protection.

Decision Framework (Fast Yes/No Filters)

Profit, Risk, and Client Expectations

Review the following bullet points to help determine which scenario matches your business situation the closest. They will help you zero in on the optimal entity selection. 

• Low, unstable profits → Lean toward sole proprietorship.

• Higher profits and steady income → Consider LLC, possibly with S corp election.

• High liability industry or client contracts require LLC status → Form an LLC.

State Costs & Your Bandwidth

Forming as an LLC provides more protection, while operating as a sole proprietorship is simpler. When deciding the optimal entity type for your current operations, factor in your state’s formation and any annual fees, plus your willingness to handle the added paperwork—or work with a professional.

LLC vs. Self-Employed Scenarios

Consider the following LLC vs. self-employed scenarios to continue zeroing in on the optimal business structure. 

Freelancer Netting ~$45k

• Sole prop: Simpler, lower costs, but no liability shield.

• LLC: Adds protection and credibility, but costs more annually without reducing self-employment tax.

Consultant Netting ~$120k+

• LLC with S corp election: Reasonable salary of $70k, distributions of $50k could save thousands in self-employment taxes annually—but adds payroll duties and compliance costs that may distract from in-depth consultations. 

Two-Owner E-Commerce

• Multi-member LLC: Requires an operating agreement, issuing a Schedule K-1 to each member, and allocates profits per agreement. This is great for formalizing partnerships and managing buyout terms.

How to Switch (or Elect S Corp) Smoothly

Sole Proprietor to LLC Checklist

Follow this checklist to transition from a sole proprietorship to an LLC. 

1. File formation paperwork with your state.

2. Obtain or update your EIN.

3. Open a separate business bank account.

4. Update licenses, permits, and vendor contracts.

5. Notify payment processors and platforms.

S Corp Election Timing

Timing your S corp election is an incredibly important aspect of forming as this entity type. Here's what you need to do: 

• File IRS Form 2553, Election by a Small Business Corporation, within two months and 15 days after the start of the tax year for it to apply.

• If you miss the deadline, late election relief may be available.

• Set and document reasonable compensation, and review it annually to ensure ongoing compliance.

Mistakes to Avoid

Avoid these mistakes to preserve your S corporation eligibility while staying away from penalties and increased IRS scrutiny. 

• Mixing personal and business funds.

• Missing state annual reports.

• Taking distributions without first paying a salary under S corp status.

• Failing to remit payroll taxes.

A Helpful Next Step

Choosing between operating as a self-employed sole proprietor and forming an LLC isn’t just about taxes—it’s about your: 

• Risk

• Growth goals

• Overall peace of mind

Missteps can be costly, and operating as the suboptimal entity type can reduce your competitiveness in the market. When faced with consequential business tax decisions, it's best to trust the experts at 1-800Accountant, America's leading virtual accounting firm.

When you trust us with your complex financial work, your designated accountant can model your potential tax savings, walk you through state-specific costs to minimize surprises, and keep you compliant year-round. 

Schedule time to speak with a 1-800Accountant small business specialist for a precise determination of which structure will work best for your business.