Do I Need an LLC to Start a Business?
Written by Miho Abe
Published August 26, 2025
There are many adages about business are not universally true: "The customer is always right," "It takes money to make money," and so on. Today, we're adding one more to the list: "You need an LLC to have a business."
The truth is, you don’t need to open an LLC to have a small business. In fact, many people operate as sole proprietors without ever filing a single legal form. But whether or not you should form an LLC is another story—and it depends on your goals, how much risk you’re taking on, and what kind of taxes you’re ready to deal with.
Let’s break it down.
Sole proprietorship 101
If you start working for yourself—say you’re a freelance designer, dog walker, or run an online shop—you’re automatically a sole proprietor by default. No paperwork required.
How do sole proprietors report their earnings?
As a sole proprietor, your business income is reported and taxed on your individual 1040 tax return. Neither the IRS nor California’s Franchise Tax Board sees your business as a separate entity you and your business are legally the same thing. Come tax season, you’ll report your business income and expenses on Schedule C, which gets attached to your personal 1040 return.
What taxes do sole proprietors pay?
Sole proprietors are expected to pay all the same taxes as W-2 employees, namely: Income, Social Security, and Medicare (also known as FICA).
Here’s the rub: As a sole proprietor, you’re considered your own boss, which means you’re required to pay the employer’s portion of your FICA bill – an additional 7.65%. Meaning, your total FICA bill is 15.3%. Ouch. This higher rate is commonly referred to as the self-employment tax.
Luckily, you can soften the blow with business deductions. Common examples include:
💻 Internet
📱 Phone
🍽️ Business meals
🚗 Mileage
🏠 Home office
These write-offs reduce your taxable income, which means less self-employment tax due. Still, it’s a bigger tax burden than most W-2 employees are used to.
What liability protection do sole proprietors have?
There are a lot of benefits that come with running your business as a sole proprietor, but one big drawback is that sole proprietorships don’t provide owners with limited liability.
What does this mean? Well, as a sole proprietor, you’re personally liable for all debts and other liabilities incurred by your business. A business creditor can go after all of your assets, including your personal assets, when you owe them money.
This means that your personal bank accounts, car, and even your house could be at risk. While these risks can be mitigated with insurance and other measures, many people consider getting an LLC for the added protection.
When you should consider an LLC
If you want personal liability protection and a more formal business structure, you can form an LLC. It takes a bit of paperwork and a filing fee, but you’ll separate your personal assets from your business. Great for freelancers, small business owners, or anyone who wants to look more professional.
Let’s take a closer look at the three main reasons you might want an LLC.
You need liability protection
One of the biggest reasons people form an LLC (Limited Liability Company) is for legal protection. It creates a “wall” between you and your business at the state level, so if your business ever gets sued, your personal stuff—like your house or savings—is usually safer.
On the tax side, a single-member LLC (SMLLC) is generally treated like a sole proprietorship by the IRS. That means you can still report your business income on Schedule C and pay self-employment tax unless you decide to choose a different tax option.
You want to set up an S-Corporation
LLCs can elect to be treated as “S-Corporations” for tax purposes. This IRS designation creates a tax distinction between you and your business at the federal level and can create more tax planning opportunities.
For example, S-Corporation owners have the option to pay themselves a reasonable salary that's subject to Social Security and Medicare taxes, but the rest of the profits can be taken as dividends—which aren’t subject to those taxes. This strategy is a creative way to shield a portion of your earnings from the 15.3% self-employment tax.
You want to formalize your business
Despite an LLC having little meaningful impact on how you operate, it does signal to customers that you have a formal business - even if you're still a one person show. Many people set up LLC's just to add more credibility to their business.
What should I know if I register an LLC in California?
Here’s where things get pricey.
Brace for California’s Franchise Tax
Forming an LLC in California means you’re on the hook for the $800 annual franchise tax, no matter how much (or how little) your business makes. That’s the minimum.
This annual tax isn’t imposed on sole proprietors. If you decide to form an SMLLC or LLC instead of working as a sole proprietor, you’ll need to allocate at least $800 annually to pay this tax.
Expect Additional Filing Requirements
In addition to the franchise tax, California LLCs must meet the following filing requirements:
- Form 568: This is the Limited Liability Company Return of Income and must be included with your California Form 540 (individual income tax return) if you’re a single-member LLC.
- Statement of Information: You must file this with the California Secretary of State within 90 days of formation and every year thereafter. This form provides basic information about your LLC, such as addresses, officers, and the nature of your business.
Prepare for higher tax preparation fees
Since you’re dealing with extra forms and state requirements, expect to pay more for tax preparation if you use a professional. Even DIY software may charge more for LLC returns.
Bottom line: You don’t need an LLC to run a business federally and in most states. But if you want some legal protection, a more professional image, and don’t mind the cost and paperwork, an LLC might be worth it. Just make sure you’re aware of the fees, forms, and tax implications before you dive in.