The difference between S Corp and sole proprietorships is that owners of S corporations have limited liability protection. This protection is not available to owners of a sole proprietorship. Sole proprietorships have the advantage of having no registration and maintenance requirements compared with S-corps, which have a number of registration requirements, annual filing requirements, and fees. 

S-Corp or Sole Proprietorship: Which Is Right for You?

Potential business owners are faced with the weighty decision of choosing a business type. On the one hand, the sole proprietorship offers an easy-to-create and maintenance-free gateway to the business world. On the other hand, the S corporation gives you limited liability protection and some tax advantages. 

The sole proprietorship business concept favors freelancers and is the traditional business type run by one person. Many people work under this business model without even realizing it. The S corporation, on the other hand, is not even a real business type. It is a tax classification that the IRS has availed to some corporations and LLCs to enable them to avoid double taxation

Both business types are not subject to double taxation, an inescapable cost of doing business for traditional corporations. And as pass-through entities, they can both benefit from the new 20 percent pass-through tax deduction established by the new Tax Cuts and Jobs Act. The key differences between S-corps and sole proprietorships are discussed below.

Ownership and Management 

  • Shareholders
    A sole proprietorship can have just one owner, but an S corporation can have up to 100 shareholders or members.
  • Formation
    The sole proprietorship is the easiest business to start and run. The only documentation you need to start a sole proprietorship is a license or permit relevant to your type of business.
  • Management Requirements
    If the S-corp is a corporation, it needs to have a board of directors, hold a number of management meetings, and hold an annual shareholders meeting.
  • Maintenance
    S-corps are required to file annual paperwork and pay fees just to maintain the business in most states.

Liability Protection

A sole proprietorship is not a separate legal entity from its owners. Sole proprietorships do not offer liability protection like S-corps. If the owner gets a loan for the business and fails to pay, the lender can come after the owner's personal assets to cover the debt. Owners of S corporations are still personally liable for loans they personally guaranteed, but the S corporation offers a considerable advantage to business owners in this area.

Taxes: S Corporation Versus Sole Proprietorship

  • IRS Requirements
    Since a sole proprietorship is not distinguishable from its owner, taxes for the business are paid on the owner's tax account. The tax returns are filed using the owner's personal tax return, Form 1040.
  • Employee Taxes
    Sole proprietors don't pay payroll taxes, but S corporations that have employees are required to file those taxes. The sole proprietor does not need to have worker's compensation insurance or unemployment insurance, but these are a must for S corporations that have employees. Sole proprietors instead pay self-employment taxes, including Social Security and Medicare taxes.
  • Social Security and Medicare Taxes
    While all of the sole proprietor's income is subject to FICA taxes, S-corp employee shareholders may legally circumvent paying a portion of the taxes. This can be done by drawing out a portion of their income as earnings instead of wages. The earnings are not subject to FICA taxes, but the salaries of employee shareholders are still subject to the taxes.
    For example, if you are the sole owner and employee of an S-corp and the business makes a profit of $150,000 in a year, and paid you a reasonable salary of $50,000, you get the remaining $100,000 as distribution. The $50,000 salary would qualify for FICA (Social Security and Medicare) taxes at a rate of 12.4 percent and 2.9 percent respectively. You would pay just $7,650 for FICA taxes, compared with $22,950 if the business was a sole proprietorship.
  • Minimum Annual Taxes
    Different states have adopted differing approaches towards taxation of S corporations. Many states have minimum franchise taxes for all S corporations. These taxes don't apply to sole proprietorships.

A sole proprietorship is suitable for a person who wants to go into business without being subjected to the stringent state and federal requirements of other entity types. However, business owners who want to get limited liability protection or co-own need to file as S-corporations.

If you need help to choose between an S-corp and a sole proprietorship, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.