LLC vs Sole Proprietor for Contractors: What It Protects

A contractor I’ll call Dave framed a basement, the subfloor got wet behind a bad vapor barrier, and eighteen months later the homeowner sued for $92,000 in mold remediation and lost rent. Dave had an LLC. He also had no general liability policy, because he’d let it lapse over the winter when work was slow.

The LLC did not save his house. The lawsuit named him personally as the person who did the work, and that claim survived.

That’s the thing nobody tells you when they say “just form an LLC.” An LLC is a real and useful tool. It just doesn’t protect against the thing most contractors think it protects against. Here’s what it actually does, where it holds, where it fails, and what the tax difference is worth in dollars at a few revenue levels.

What a sole proprietorship actually is

You don’t form a sole proprietorship. You become one by doing work for money. If you swung a hammer for pay last Saturday and never filed anything, you are a sole proprietor right now.

Legally, there’s no separation between you and the business. The business’s debts are your debts. The business’s lawsuits are your lawsuits. Your truck, your savings, your home equity (subject to your state’s homestead exemption) are all on the table.

Cost: $0 to start, maybe $15–$50 for a DBA filing if you want to operate under a name other than your own.

What an LLC actually is

A Limited Liability Company is a legal entity separate from you. It can own things, sign contracts, get sued, and go broke — ideally without taking you with it.

Cost varies wildly by state. Formation fees run roughly $50 to $500. Annual fees or franchise taxes run from $0 to several hundred, with California’s $800 minimum franchise tax being the one that makes contractors there think twice. Go look up your specific state’s formation fee and annual report fee before you budget for this — the spread between states is large enough to change the math.

The part that matters: what the shield covers

Here’s the mental model. The LLC protects you from liabilities the company incurs. It does not protect you from liabilities you personally incur, even while working for the company.

Scenario 1: The LLC holds

You hire a guy. He backs the dump trailer into a client’s Lexus. Client sues for $14,000. Your general liability policy has a $1,000 deductible and covers the rest, but say the claim had been $400,000 and blown through your limits. The excess is a company debt. Creditors can come after company assets — the trailer, the bank account, the tools titled to the LLC. Your personal house is generally out of reach.

This is the core case the LLC is built for: liability from employees, subs, contracts, and company debts.

Scenario 2: The LLC holds

You sign a $38,000 materials account with a supplier, in the LLC’s name, no personal guarantee. The job goes sideways, the GC above you doesn’t pay, and you can’t cover the account. The supplier sues the LLC. If the company has no money, the supplier is largely out of luck. Your personal savings are not reachable.

Note the condition: no personal guarantee. Most suppliers and every bank will ask you to sign one. The moment you do, you’ve waived the shield for that specific debt. Read what you sign.

Scenario 3: The LLC does NOT hold

You personally install a water heater. You don’t strap it. It topples, the T&P line snaps, and the house floods. The homeowner sues.

They sue the LLC and they sue you, personally, for negligence in performing the work. Courts in essentially every state allow this. An owner who personally commits a tort is personally liable for it, regardless of what entity is on the invoice.

This is the single biggest misunderstanding in the trades. If you are the one doing the work, the LLC does not shield you from your own workmanship. Insurance does. That’s what general liability is for, and it’s why the insurance question is not optional for a solo operator. An LLC with no GL policy is a one-person shop with extra paperwork.

Scenario 4: The LLC does NOT hold

You pay your personal mortgage out of the business checking account. You pay for a company compressor with your personal card and never reimburse. You never filed the annual report. There’s no operating agreement.

A plaintiff’s attorney asks for two years of bank statements, finds the commingling, and argues the LLC is a sham — “piercing the corporate veil.” This succeeds more often against single-member LLCs than people expect, and it succeeds almost entirely because of sloppy bookkeeping, not because of anything complicated.

Scenario 5: The LLC does NOT hold

Unpaid payroll taxes. The IRS can assess the Trust Fund Recovery Penalty against you personally as a responsible party. No entity protects you from that one.

The summary table

Risk	LLC protects you?
Employee or sub causes damage	Yes
Company debt, no personal guarantee	Yes
Company debt, personal guarantee signed	No
Your own hands-on workmanship	No
Your own negligent driving	No
Commingled funds / no formalities	No
Unpaid payroll taxes	No
Licensing violations	No (state board goes after the licensee)

Look at that table honestly. If you’re a solo operator doing all the work yourself, roughly half the realistic ways you get sued are ways the LLC doesn’t cover.

That doesn’t mean skip it. It means buy the insurance first, then form the LLC. Insurance is the primary defense. The LLC is the backstop for the categories insurance doesn’t reach or where limits get blown.

The tax math

Here’s where the LLC actually pays for itself for a lot of contractors — and it has nothing to do with liability.

By default, a single-member LLC is taxed exactly like a sole proprietorship. Schedule C, self-employment tax on all net profit, no difference. Zero tax savings. Anyone who tells you forming an LLC cuts your taxes is skipping a step.

The savings come from electing S-corporation taxation on top of the LLC. You can only do that with an entity. Under an S-corp election, you split your profit into two buckets:

A reasonable W-2 salary you pay yourself, subject to the 15.3% self-employment/payroll tax.
The remaining profit, taken as a distribution, not subject to that 15.3%.

Income tax applies either way. The savings are purely on the self-employment side.

Worked numbers

Say your net business profit — revenue minus all expenses, before paying yourself — lands at three different levels. Assume a reasonable salary set at roughly 60% of profit, which is a common ballpark but must be defensible for your trade and market; the IRS audits unreasonably low salaries.

Net profit	Sole prop SE tax (~15.3%)	S-corp salary	Payroll tax on salary	Distribution	S-corp payroll tax	Gross savings
$80,000	$11,304	$48,000	$7,344	$32,000	$7,344	$3,960
$150,000	$21,195	$90,000	$13,770	$60,000	$13,770	$7,425
$250,000	$33,077	$150,000	$20,129	$100,000	$20,129	$12,948

(SE tax figures account for the deductible-half adjustment and the Social Security wage base cut-off, so they’re approximate. Your accountant will produce the exact number.)

Now subtract the cost of running an S-corp:

Added cost	Typical annual range
Payroll service	$500–$1,200
Separate business tax return (1120-S)	$800–$2,000
Added bookkeeping rigor	$0–$1,500
Total	$1,300–$4,700

At $80,000 of profit, the $3,960 in savings can be mostly eaten by $3,000 in compliance cost. It’s marginal. At $150,000, you’re netting a few thousand. At $250,000, it’s clearly worth it.

The rough crossover for most contractors is somewhere around $80,000–$100,000 in net profit — not revenue. If you’re grossing $200,000 and netting $55,000 after materials, subs, and overhead, you are not there yet. If you don’t know your net profit cold, that’s a bookkeeping problem to fix before it’s a tax-structure problem, and good job-costing and invoicing habits are the prerequisite.

One more thing the S-corp costs you: a lower W-2 salary means lower Social Security credits later, and it can shrink what a lender will qualify you for on a mortgage. Both real. Both usually outweighed by the savings at higher profit levels, but worth knowing.

What to actually do

For most contractors, the sequence looks like this:

Start working. You’re a sole proprietor by default. Don’t let entity paperwork delay your first paying job.
Get general liability insurance before the first job with real exposure. This is the actual protection.
Get your license squared away if your state and trade require one — the entity question is separate from and secondary to licensing.
Form the LLC once you have real assets to protect, employees or subs, or contracts worth more than a few thousand dollars. For many people that’s month three, not year three.
Open a separate business bank account the same week you form it. Never pay a personal bill from it. This single habit is most of what keeps the veil intact.
Revisit the S-corp election when net profit clears about $80,000, with an accountant who works with contractors.

Your next step

Pull last year’s numbers and find your actual net profit — revenue minus materials, subs, insurance, truck, tools, and everything else, before what you paid yourself. That one number tells you whether this is a liability conversation or a tax conversation.

If it’s under $80,000, stop reading about S-corps. Form the LLC, buy the insurance, open the separate account, and get back to selling work.