Taking the leap of faith and starting your own travel agency can be new and exciting until it comes time to choose a business structure. There are numerous different types of business structures, all of which retain advantages and disadvantages.
However, many travel agents lean towards an LLC or sole proprietorship setup because of its simplicity. Understanding the primary differences between each business entity will help you determine which one is right for your new business.
The Basics of an LLC vs Sole Proprietorship
LLCs and sole proprietorships share similarities in the taxation process, but have key differences in growth and expansion opportunities.
Sole Proprietorship
A sole proprietorship is an unincorporated business owned and managed by one individual. A sole proprietor cannot bring any additional partners into the business because of the way the income or loss is taxed.
Limited Liability Company
LLC or limited liability company, is a legal entity that is formed at the state level. Generally, the state the business operates in will be the state the LLC is formed in.
LLCs can take on two forms: a single member LLC or a multi member LLC. A single member LLC is very similar to a sole proprietorship in how tax is reported and paid while a multi member LLC allows travel agents to have multiple partners.
How to Choose a Sole Proprietorship vs LLC?
The consideration of an LLC vs sole proprietorship extends beyond just the setup process. In fact, there are countless considerations you will need to evaluate to find the right business structure for your travel business.
Ownership
Sole proprietors are the only individual that reports income or loss in the business. This is because all income is reported on the personal tax return on Schedule C. Single member LLCs report income in the same way as sole proprietorships while multi-member LLCs pass through taxation to each member.
Tax Implications
Another primary difference between an LLC and sole proprietorship is the tax implications. A sole proprietor reports all income or loss on their personal income tax return, meaning they are responsible for paying taxes on all income.
LLCs that have multiple members will have pass through taxation to each member according to their ownership percentage, resulting in the potential for a lower tax liability on the income tax return compared to sole proprietorships.
Sole proprietors and members of an LLC will be required to pay self employment taxes on the business income. The IRS treats both of these businesses as being self employed, requiring the owners to pay taxes at the ordinary income level and self employed level. The tax benefits, such as offsetting one-half of the employment taxes as a credit, can help reduce your liability.
There are tax benefits for both of these business structures, including credits and deductions geared toward business owners that can be claimed on the tax return. Payroll taxes are also another consideration when choosing between these structures. Taking a salary out of your business and paying employees is generally easier with an LLC.
Distributions
When your travel business starts to turn a profit, there are limits on how much money you can take out, depending on your structure. An LLC vs sole proprietorship differs in how money is taken out.
Since a sole proprietor is a business structure with no partners, they can take whatever distributions they want. A single member LLC is able to take distributions similar to sole proprietorships.
Multi member LLCs are required to take pro rata distributions. This means that the distribution must be proportionate to their ownership percentage. For example, if you own 50% of the travel agency and want to take $10,000, the LLC would be required to distribute $10,000 to the other 50% of ownership.
Depending on how much you want to take out of the business each year, one business entity might be more favorable.
Business Debts
Sole proprietors are personally responsible for business debts. If your business defaults on a loan or line of credit, there is minimal liability protection between you and the lender. On the other hand, LLCs have more personal liability protection. If the business defaults, the amount you are required to repay depends on your ownership percentage and the partner type you are.
General partners will have little personal liability protection similar to a sole proprietor while limited partners have personal liability protection up until their basis amount. The basis of the company is how much money the member has earned, contributed, and distributed.
Business Formation
Forming an LLC requires more forms to be filed, especially when multiple partners are involved. Limited liability companies that have more than one partner are required to create an operating agreement. An operating agreement outlines the income and loss percentages along with how money can be taken out of the company.
An LLC is also required to file articles of organization when they register the business. You may need to enlist the help of a lawyer to draft proper articles of organization for your travel agency. Additionally, working with a registered agent can help you ensure you are filing the proper forms to create a legal business.
Regardless of if you start a business as a sole proprietor or LLC, you will need to determine a business name for your travel agency. The name must not be already taken and should help customers identify your primary business activity. An LLC will go through the business name claiming process while a sole proprietor might report and pay taxes under their legal name.
Personal Liability Protection
Personal liability is another major factor to consider. A limited liability company has more protection compared to a sole proprietorship. This is because personal assets are generally separated from business assets. If your business is sued and the courts see that you mix business and personal assets, you may be required to pay lawsuit costs from personal funds.
Not only can your business face bankruptcy, but your personal life can be dramatically impacted. Legal protection is one of the main reasons that travel agents set up an LLC instead of a sole proprietorship.
Avoiding being personally liable can be done by having a separate bank account in the business name and running all transactions through there. Minimizing the debts and obligations your business faces is critical as a business owner. You want to protect your personal assets, such as your home, retirement accounts, and checking accounts.
However, if you choose to set up a sole proprietorship, keeping personal finances separate from business expenses and income with a different bank account is a great first step in safeguarding your personal assets. The more liability protection you can implement, the easier it will be to report accurate tax returns and maintain proper segregation between income and expenses.
Start-Up Costs
When it comes time to form an LLC or sole proprietorship, there are costs to factor in. Setting up an LLC requires travel agents to register with the corresponding Secretary of State, depending on where the business is formed. You will be responsible for paying a filing fee to register your business, which varies by state.
Single member LLCs don’t need to apply for an EIN or register with the IRS, but multi member LLCs do. Generally, the only requirement to form an LLC is to register with the respective state. You will need to know key information about your business including any partners, the designated partnership representative, business address, and ownership percentages.
To start a sole proprietorship, there are fewer filing fees and requirements compared to an LLC formation. The business structure of a sole proprietorship works great for a small business owner, such as a travel agent.
Growth Options
Choosing between an LLC vs sole proprietorship also factors in growth opportunities. Small business owners that are looking to scale significantly in the upcoming years might want to set up an LLC from the start. This is because there are more growth opportunities to add on more partners and minimize their tax burden compared to a sole proprietorship.
A sole proprietor cannot bring on any additional partners unless they change structures. This is one of the main disadvantages of sole proprietorships. A single member LLC can easily adapt to add additional partners on, giving access to capital and other resources.
Record Keeping
Both an LLC and a sole proprietorship have record keeping burdens for liability protection and tax reporting. A limited liability company LLC has a greater record keeping burden because of the different agencies that they report to. Staying on top of LLC filing requirements, such as annual reports and remittances, can take away from your time as a travel agent. Like an LLC, sole proprietorships also have record keeping burdens, but these are often less in scope compared to an LLC.
Summary
Choosing the right structure for your business can seem overwhelming with both an LLC and sole proprietorship retaining advantages and disadvantages. A sole proprietorship and LLC are two common business entity types when choosing to start a travel agency.
The main differentiating factors come down to if you want to be personally responsible and personally liable for all business operations.
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