S Corp vs. Sole Proprietorship: What's The Difference?

The differences between the two pivot around how the two types of business structures are taxed and how much protection the owners have against being held accountable for the business operations. An S Corp has the maximum tax benefits and liability protection. With a sole proprietorship the owner and the business are treated as the same. This makes the owner open for liability and greater taxation but is easier and quicker to set up and manage. 

Pro-Advice: 

• A sole proprietorship is the easiest business structure to get started. 
• An S corp can help you protect your personal assets. 
• In addition it can offer tax savings strategies. You can start with a sole proprietorship and later transition into an S corp. 

S Corp vs. Sole Proprietorship: What’s the Difference?

When you start a business without any paperwork, that’s a sole proprietorship. So, if you haven’t created an LLC, any business activities you undertake fall into a sole proprietorship. On the other hand, an S Corp is a Limited Liability Company (LLC) with a particular tax designation. This

The major difference is that an S Corp offers liability protection for business owners. But we’ll take a closer look at all of the differences below.

Setup and Maintenance

The start up logistics and ongoing legal maintenance of a business structure is an important consideration. It’s significantly easier to set up and maintain a sole proprietorship.

• Sole proprietorship: Since a sole proprietorship is not a separate legal entity, you can set one up instantly without filling out any special paperwork. Additionally, there are no annoying paperwork requirements for a sole proprietorship. 
• S Corp: An S Corp is an organization with a special tax filing designation. As a business owner, you’ll need to file paperwork to create your LLC and additional paperwork to elect your S Corp status. After the setup, S Corps often require an annual tax filing to update the state on your business practices. 

See how to start a sole proprietorship for further information.

Legal Protection

When you are running a business, you can face either unlimited or limited liability.

With unlimited liability, business owners can face seizure of their personal assets in the event of unpaid debt or a lawsuit. With limited liability, the business owner’s personal assets are shielded from losses and debts. Here’s how this liability protection works for each business structure.

• Sole proprietorship: A sole proprietorship is not a separate legal entity. And so, it comes with unlimited liability. That's because your business assets are not at all separate from your personal assets. With that, you’ll be personally responsible for debts, losses, and lawsuits against the company. 
• S Corp: An S corp is one type of LLC, which means the business owner has limited liability. Since the business is a separate legal entity, your personal assets will not be on the line if your business owes money or faces a lawsuit. 

Tax Benefits

S Corps and sole proprietorships operate as pass-through entities. So, in either case, the profits from the business will flow to your tax filings. But an S Corp offers more tax advantages. Here's a closer look at sole proprietorship vs S Corp taxes.

• Sole proprietorship: As a sole proprietor, you’ll pay the full self-employment tax of 15.3% on all of the profits earned by your business. 
• S Corp: As an S corp owner, you have access to tax benefits. You’ll have to pay yourself a ‘reasonable salary,’ which is subject to the 15.3% self-employment tax. But you’ll also be able to take distributions from the business. The distributions will be subject to regular income taxes, but not self-employment tax. If you want to minimize your tax burden, an S Corp is usually the right option. 

Additional Concerns

The legal protections and taxation aren’t the only things to consider. A few other details include your residency status and the issues involved with choosing a reasonable salary.

• Sole proprietorship: As a sole proprietor, you can get started without too many logistics holding you back. 
• S Corp: With an S Corp, you’ll need to carefully consider what qualifies as a reasonable salary for your industry. There is no set rule, so this choice is subject to more IRS scrutiny. In most cases, you’ll want to hire a CPA to help you manage the additional legal requirements that come with managing an S Corp. You'll also need to maintain payroll to pay yourself as an employee at a cost 

 Business Dissolution

As with setting up the business, it’s easier to dissolve a sole proprietorship than an S corp. Here’s a look at each:

• Sole proprietorship: You can close the business by paying off all of your business debt, notifying the IRS, and filing any remaining taxes. 
• S Corp: If closing an S Corp, you’ll need to do all of the steps above. Additionally, you’ll need to notify your state of the closure and file more paperwork with the IRS. 

Choosing a Business Structure: S Corp vs. Sole Proprietorship

As a business owner, making a decision on the appropriate structure is one of many to make. Ultimately, the right option will vary based on your unique business goals.

S Corp Advantages

An S Corp comes with considerable advantages, including:

• Tax options: With the right payment structure, you can lower your tax burden through an S Corp. 
• Liability protection: A separate legal entity means that your personal assets won’t be on the hook for your business debts or lawsuits. 
• Easier to onboard investors: You are more likely to attract an investor if they can invest in the business as a separate legal entity. 

S Corp Disadvantages

But an S corp also comes with disadvantages, including:

• More paperwork: You’ll have to file more paperwork upfront to start an S Corp. 
• More complicated taxes: Although you can limit your tax burden, it may take the help of a professional to harness this opportunity. 
• Ongoing cost: You’ll have to pay to open your S corp. Plus, pay to regularly meet filing requirements for your state. 

When to Start an LLC Taxed as an S Corp

An S Corp isn’t the right fit for everyone. But there are some reasons that can attract business owners to open an LLC taxed as an S Corp:

• The business generates more than a reasonable salary: If the business generates enough income to pay the owner a salary and distributions, then an S Corp offers tax-saving opportunities. 
• You want to withdraw funds from the business each year: If you aren’t planning to reinvest profits each year, then an S corp offers a way to pull the funds out in a tax-advantaged way. 
• You want liability protection: The thought of putting your assets in harm’s way might not sit well with you. In that case, the liability protection of an S Corp will be appealing. 

Sole Proprietorship Advantages

An sole proprietorship comes with advantages, including:

• Easy to start: You won’t have to file any paperwork to get started. But you’ll still need to acquire any necessary licenses. For example, if you are opening a bar, you’ll need a liquor license. 
• Good way to try out business ideas: You can get things off the ground quickly to test different product and service offerings. 
• No costs: You don’t need any money to open this business structure. 

Sole Proprietorship Disadvantages

An sole proprietorship comes with disadvantages, including:

• No liability protection: Your personal assets are at risk if your business cannot pay its debts or settle a lawsuit. 
• No tax advantages: You won’t have the option to limit your self-employment taxes. 
• Difficult to onboard investors: Many investors won’t be willing to put money into a sole proprietorship due to the mix of personal and business assets. 

When to Operate a Sole Proprietorship

The ease of opening a sole proprietorship makes this a popular option. Here’s when it could be the right fit:

• Low risk business: If there isn’t too much risk of liability or financial loss tied to your business, then the lack of liability protection might not be an issue. 
• You aren’t looking to grow quickly: A business that you aren’t planning on growing too fast, and may double as a hobby, might make more sense as a sole proprietorship. 
• You have a limited customer base: If you are only planning to sell a product or service to friends and family, then an LLC might be overkill. 

When to Start a Standard LLC 

You don’t just need to consider S Corps and sole proprietorship. You’ll need to consider the benefits of an LLC vs. S Corp vs. Sole proprietorship. See sole proprietorship vs. LLC for more details. An S Corp is a tax designation for an LLC. But in some cases, it makes sense to stick with a standard LLC. A standard LLC makes sense when:

• You want liability protection: When you form an LLC, you can protect your personal assets. 
• You qualify for an LLC: Not all business types can open an LLC. For example, some states prevent law firms and doctor’s offices from forming an LLC. 
• You don’t want increased reporting requirements: An LLC comes with fewer reporting requirements than an S Corp. 

How to Start an S Corp

Starting a sole proprietorship is as easy as starting to work for yourself. But if you want to start an S corp, it’s a bit more complicated.

Steps to Forming an LLC and Electing S Corp Status

Here’s a step-by-step look at starting an LLC and choosing the S corp status.

• Name your LLC. It can be more difficult than you think to settle on the right name!
• Choose a registered agent. Generally, the business owner will act as the registered agent, who is legally authorized to make decisions for the business. 
• File the Articles of Organization for your LLC. The Articles of Organization should be filed through your state’s Secretary of State website. 
• Create an LLC Operating Agreement. This document outlines how the business will run. It’s a good idea to nail this down upfront. 
• Get an EIN. An Employer Identification Number (EIN) is issued through the IRS. You will use this number when filing tax documents and hiring employees. 
• Elect S Corp Status. You can choose S corp status on form 2553. The IRS will confirm when they receive this status election.  

FAQs about S Corps and Sole Proprietorships

Here are the answers you’ve been hunting for about S corps vs sole proprietorships.