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What's the difference between an LLC and a sole proprietorship?

If you’re working for yourself and haven’t filed anything with the state to create a business entity, you’re already a sole proprietorship. It’s the default. No paperwork, no formation cost, no annual state fees. You report your business income and expenses on Schedule C of your personal tax return and pay self-employment tax on the profit.

An LLC is a legal entity you create by filing articles of organization with the California Secretary of State. The main benefit is liability protection. If something goes wrong on a job and you get sued, the LLC creates a legal separation between your business assets and your personal assets. Your house, your personal savings, and your truck (if it’s titled personally) are harder to reach in a lawsuit. As a sole proprietor, there is no separation. Everything you own is fair game.

For anyone in the trades or construction, that liability protection matters. You’re working on other people’s property, using tools and equipment that can cause damage, and dealing with subcontractors and employees. Insurance covers a lot, but having the LLC as an additional layer of protection is worth considering.

On the tax side, a single-member LLC doesn’t change much by itself. The IRS treats it as a “disregarded entity,” which means you still file Schedule C just like a sole proprietor. The income flows to your personal return the same way. The LLC doesn’t automatically save you on taxes.

The tax savings people hear about usually come from electing S-corp status, which is a separate step. That’s worth exploring once your net profit is consistently high enough to justify it, but it adds complexity and payroll requirements. A CPA who works with trade businesses can help you figure out when that election actually makes sense for your situation rather than just following generic advice you found online.

The biggest drawback of an LLC in California is cost. The state charges a minimum $800 franchise tax every year regardless of whether you made any money. That hits hard if you’re just getting started or if your business is seasonal. A sole proprietorship has no equivalent fee.

There are also practical reasons to form an LLC. Some general contractors require subs to have an LLC before they’ll work with them. Lenders and suppliers may take you more seriously. And it keeps your business looking professional, which matters when you’re bidding larger jobs.

The bottom line is that a sole proprietorship is simpler and cheaper to maintain, while an LLC gives you liability protection and more flexibility as you grow. Most trade business owners benefit from forming an LLC once the business is generating steady revenue, but the timing depends on your specific numbers. If you’re not sure where you stand, getting tax strategy guidance before making the decision will save you from either paying the $800 too early or waiting too long and leaving yourself exposed.

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More Questions

Can I deduct my truck if I use it for my contracting business?

Yes, but only the business-use portion. You can deduct truck costs using either the standard mileage rate or the actual expense method, and heavier trucks may qualify for a full first-year write-off under Section 179.

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How do I keep a mileage log for the IRS?

Record the date, destination, business purpose, and miles driven for every trip, and do it the same day. The IRS requires contemporaneous records, so a log recreated at year end won't hold up in an audit.

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When is the deadline for filing a business tax return?

It depends on your business structure. Partnerships and S-corporations are due March 15. Sole proprietors and C-corporations are due April 15. Extensions are available but don't extend your time to pay.

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When should I switch from sole proprietor to LLC?

Most trade and service business owners should consider forming an LLC once they have real liability exposure, steady income, or assets worth protecting. The tax benefits of an LLC with an S-corp election typically kick in when net profit exceeds $40,000 to $50,000 annually.

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What are the tax benefits of an S-corp for contractors?

The biggest benefit is reducing self-employment tax. Instead of paying 15.3% on all your net profit, you only pay payroll taxes on your salary and take the rest as distributions that avoid that tax.

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What financial documents do I need to get a business loan?

Lenders typically want two to three years of tax returns, a current profit and loss statement, a balance sheet, bank statements, and a debt schedule. Having clean, up-to-date books makes the difference between a smooth application and a scramble.

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Long Beach CPA firm specializing in contractors, trades, and service businesses. Bookkeeping, tax preparation, IRS representation, and advisory services for businesses across the South Bay and Greater LA. Owned and operated by a CPA with over a decade of hands-on experience.

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