Form an LLC when your business carries real risk of debts or lawsuits that could reach your house and savings, and your state's yearly fee is a cost you can carry. An LLC separates the business's debts from your personal assets in most cases, but a single-member LLC is taxed exactly like a sole proprietorship by default, so it does not lower your taxes by itself. If you run a low-risk side business in a state with high LLC fees, staying a sole proprietor with good insurance is a reasonable choice until that changes, and you can form the LLC later.
What does an LLC actually protect?
An LLC protects your personal assets from the business's own debts and obligations. The SBA puts it this way: with an LLC, in most instances your vehicle, house, and savings won't be at risk for what the business owes. As a sole proprietor, you can be held personally liable for the business's debts. If your LLC defaults on a supplier bill or loses a contract dispute, the creditor generally goes after the LLC's assets, not yours.
What doesn't an LLC protect you from?
An LLC does not protect you from your own mistakes, from debts you personally guarantee, or from unpaid payroll taxes.
- Your own conduct. State LLC laws keep members liable for their own wrongdoing. California's statute, for example, says LLC debts belong to the LLC but does not limit a member's liability for "the member's participation in tortious conduct". If you personally cause an injury or damage, the LLC is not a wall between you and the claim.
- Personal guarantees. The same statute preserves liability under "a written guarantee". Many landlords, lenders, and card issuers ask a new business owner to sign one.
- Piercing the veil. Courts can disregard the LLC when owners treat it as a personal piggy bank. Factors include commingling of assets, undercapitalization, failure to observe formalities, and fraud, and tests vary by state. Mixing personal and business money is the most common way owners lose LLC protection.
- Unpaid payroll taxes. If you have employees, the IRS can hold any "responsible person" personally liable through the Trust Fund Recovery Penalty, equal to the unpaid income tax withholding and employee share of Social Security and Medicare. The penalty requires willfulness, and the LLC does not shield you from it.
Insurance covers much of what the LLC doesn't. General liability and professional liability policies pay for injury claims, property damage, and negligence, including the legal defense. For many small businesses, the insurance policy is the first line of defense and the LLC is the second.
Does an LLC lower my taxes?
No, not by itself. A single-member LLC is disregarded as separate from its owner for income tax unless it files Form 8832 to be treated as a corporation. You report the profit on Schedule C of your Form 1040, the same form a sole proprietor uses.
You also pay the same 15.3% self-employment tax (12.4% Social Security plus 2.9% Medicare) once net self-employment earnings reach $400. The SBA confirms that LLC members are considered self-employed for this purpose.
An LLC with two or more members is taxed as a partnership by default, which means a separate partnership return. For a line-by-line comparison, see sole proprietor vs. LLC vs. S corp.
What about the S corp election?
The tax savings people associate with LLCs come from a separate, optional step: electing S corporation status after you form the LLC. You file Form 2553, with every shareholder's consent, and the IRS then taxes the LLC as an S corporation.
The trade-off is payroll. An S corp must pay its working owner wages that are reasonable compensation for the services rendered, judged by factors like your training, duties, time spent, and what comparable businesses pay. Social Security and Medicare apply to that salary. Profit above it can come out as distributions without those taxes.
A few rules to know before you plan on it:
- Timing. File no more than 2 months and 15 days after the start of the tax year you want it to take effect, or any time in the year before. Late-election relief exists if you have reasonable cause.
- Eligibility. The company must be domestic, with no more than 100 shareholders, one class of stock, and only allowable shareholders (individuals and certain trusts and estates; no partnerships, corporations, or nonresident aliens).
- Extra costs. Running payroll, filing a separate Form 1120-S return, and paying state unemployment tax on your salary all come with the election.
This is a decision worth making with a CPA, because the right salary and the break-even point depend on your profit, your state, and your other income. When the election makes sense depends mostly on how much the business earns.
Worked example: $80,000 of profit, three ways
Take a one-owner business with $80,000 of net profit in 2026, before any pay to the owner. This compares federal self-employment and payroll taxes first; the income-tax effect follows below the table.
| Structure | Taxable base | Self-employment or payroll tax |
|---|---|---|
| Sole proprietor | $80,000 × 92.35% = $73,880 | $73,880 × 15.3% = $11,304 |
| Single-member LLC (default) | $80,000 × 92.35% = $73,880 | $73,880 × 15.3% = $11,304 |
| LLC with S corp election, $50,000 salary | $50,000 salary | $50,000 × 15.3% + $42 FUTA = $7,692 |
The first two rows are identical. Forming the LLC changed nothing about the tax.
With the S corp election, the business pays 7.65% and withholds 7.65% from you on the $50,000 salary, plus federal unemployment tax of 0.6% on the first $7,000 (the rate with the full state credit; a few states lose part of that credit, which raises it). The employer share and FUTA are business expenses, so $26,133 of profit is left to take as a distribution without Social Security or Medicare tax. The payroll-tax gap is $11,304 − $7,692 = $3,612.
That $3,612 is not what you keep. Your salary doesn't count toward the 20% qualified business income deduction, so for a single filer with no other income, income tax rises by about $1,426 and the net federal saving is about $2,186. The full math is in how to pay yourself from an LLC. Both figures come before the cost of running payroll, preparing the Form 1120-S, state unemployment tax on the salary, and any state entity taxes.
The $50,000 salary is an assumption for the math, not a recommendation. Your salary has to be reasonable for your work, and the IRS can reclassify distributions as wages if it isn't.
How much does an LLC cost?
Each state sets its own fees, and the yearly cost matters more than the filing fee. The SBA says the total cost to register is usually under $300, but the recurring fees range from almost nothing to $800 a year or more.
| State | Formation fee | Recurring cost |
|---|---|---|
| California | $70 (Form LLC-1) | $800 annual tax plus a $20 Statement of Information every two years |
| Kentucky | $40 | $15 annual report |
| Texas | $300 (Form 205) | No franchise tax owed at or below $2,650,000 in revenue for 2026 reports, but an annual information report is still required |
California's $800 tax is due every year even if you are not conducting business, until you cancel the LLC. The first-year exemption applied only to tax years 2021 through 2023, so it does not help you in 2026. Once California total income reaches $250,000, an additional LLC fee starting at $900 applies on top.
Over five years, counting state fees only (no registered agent or optional services):
- California: $70 + ($800 × 5) + ($20 × 3 Statements of Information) = $4,130, assuming income under $250,000.
- Kentucky: $40 + four or five $15 annual reports = $100 to $115, depending on whether a report falls due in the first year.
- Texas: $300 formation and no franchise tax at small-business revenue = $300.
You also need a registered agent in your state before you file. You can serve as your own or pay a service.
Should I form my LLC in Delaware or Wyoming?
Usually not, if your business operates locally. An LLC must register in each state where it conducts business, so a Delaware LLC run from California also registers in California as a foreign LLC and owes California's $800 annual tax on top of Delaware's $400 annual tax.
Do I need to file a BOI report for my new LLC?
No, not if it is a U.S. company. FinCEN now states that U.S. companies are no longer required to file BOI reports. A final rule published August 14, 2026 permanently removed the requirement for U.S. companies and U.S. persons, and FinCEN says it will delete information U.S. persons already reported. Many older articles still say otherwise. Treat any paid "BOI filing service" offer for a domestic LLC with suspicion.
When is staying a sole proprietor reasonable?
Staying a sole proprietor is reasonable when the business has little liability exposure and an LLC's recurring cost is large relative to what you earn. A freelance designer with no employees, no lease, and a professional liability policy faces less liability exposure than a café with a storefront, staff, and customers walking in.
Signs that tip the decision toward an LLC:
- You are signing a lease, taking on business debt, or entering contracts large enough to hurt you personally.
- Customers visit your premises, or your work could injure someone or damage their property.
- You are about to hire employees.
- Your profit is climbing toward the range where an S corp election might pay off.
- You own a home or savings you would lose in a judgment against the business.
A sole proprietor using a trade name will usually need to register a DBA with the state, but a DBA gives no legal protection by itself.
What to do next
- Price the insurance first. Get quotes for general and professional liability, since you likely need coverage either way.
- Look up your state's formation and annual fees with the SBA state registration lookup and add up five years, as in the example above.
- If you form the LLC, open a separate business bank account as soon as it is approved, and keep business and personal money apart from day one.
- Get an EIN if you need one. It is free from the IRS. See whether you need an EIN.
- Revisit the S corp question with a CPA once profit grows. If you elect it, you will need to pay yourself a salary through payroll. CheckMate runs payroll for solo owners paying themselves and charges only when you run payroll, with no monthly fee.
FAQ
Can I form an LLC later? Yes. You can operate as a sole proprietor now and form an LLC when your risk or revenue grows. In California, the $800 annual tax applies from the year you file with the Secretary of State.
Does a single-member LLC file its own tax return? Not by default. The owner reports the business on Schedule C, E, or F of Form 1040. A multi-member LLC files a partnership return.
Does my LLC need an EIN? A single-member LLC with no employees and no excise tax liability can use the owner's SSN. You need an EIN to hire employees, to have more than one member, or to elect corporate tax treatment.
Who is the employer if my single-member LLC hires someone? The LLC. A disregarded LLC is treated as a separate entity for employment tax, so it uses its own EIN to withhold and pay payroll taxes.
Do I owe California's $800 if my LLC made no money? Yes. The tax is due every year until you cancel the LLC, whether or not it did business. Canceling with a short form within one year of organizing avoids the first year's tax.
What happens to my LLC if a member leaves? It depends on the state. The SBA notes that in some states, when a member joins or leaves, the LLC may have to be dissolved and re-formed. Your operating agreement should address this.
Sources
- SBA, Choose a business structure: https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
- SBA, Register your business: https://www.sba.gov/business-guide/launch-your-business/register-your-business
- SBA, State registration lookup: https://www.sba.gov/counseling/launch-your-business/state-registration-lookup/
- SBA, Get business insurance: https://www.sba.gov/business-guide/launch-your-business/get-business-insurance
- IRS, Single member limited liability companies: https://www.irs.gov/businesses/small-businesses-self-employed/single-member-limited-liability-companies
- IRS, Limited liability company (LLC): https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc
- IRS, Sole proprietorships: https://www.irs.gov/businesses/small-businesses-self-employed/sole-proprietorships
- IRS, Self-employment tax (Social Security and Medicare taxes): https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes
- IRS, Instructions for Form 2553: https://www.irs.gov/instructions/i2553
- IRS, S corporations: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations
- IRS, S corporation compensation and medical insurance issues: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues
- IRS, Employment taxes and the Trust Fund Recovery Penalty: https://www.irs.gov/businesses/small-businesses-self-employed/employment-taxes-and-the-trust-fund-recovery-penalty-tfrp
- IRS, Get an employer identification number: https://www.irs.gov/businesses/small-businesses-self-employed/get-an-employer-identification-number
- California Corporations Code §17703.04: https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=CORP§ionNum=17703.04
- Cornell Legal Information Institute, Piercing the corporate veil: https://www.law.cornell.edu/wex/piercing_the_corporate_veil
- California Franchise Tax Board, Limited liability company: https://www.ftb.ca.gov/file/business/types/limited-liability-company/index.html
- California Secretary of State, Business entities fee schedule: https://bpd.cdn.sos.ca.gov/pdf/be-fee-schedule-062018.pdf
- California Secretary of State, Business entities FAQs: https://www.sos.ca.gov/business-programs/business-entities/faqs
- Kentucky Secretary of State, Business filing fees: https://www.sos.ky.gov/bus/business-filings/Pages/Fees.aspx
- Texas Secretary of State, Form 205 instructions: https://www.sos.state.tx.us/corp/instructions/205.shtml
- Texas Comptroller, Franchise tax: https://comptroller.texas.gov/taxes/franchise/
- Delaware Division of Corporations, LLC/LP/GP annual tax instructions: https://corp.delaware.gov/alt-entitytaxinstructions/
- FinCEN, Beneficial ownership information: https://www.fincen.gov/boi
- FinCEN, FinCEN permanently ends beneficial ownership reporting requirements (August 11, 2026): https://www.fincen.gov/news/news-releases/fincen-permanently-ends-beneficial-ownership-reporting-requirements-millions
- Federal Register, Beneficial Ownership Information Reporting Requirement Revision (August 14, 2026): https://www.federalregister.gov/documents/2026/08/14/2026-16576/beneficial-ownership-information-reporting-requirement-revision
- IRS, Topic no. 554, Self-employment tax: https://www.irs.gov/taxtopics/tc554
- IRS, Publication 15 (2026), Employer's Tax Guide: https://www.irs.gov/publications/p15
- 26 U.S.C. § 199A, qualified business income: https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section199A&num=0&edition=prelim