S Corp vs LLC vs Sole Proprietorship: Everything You Need to Know
Deciding how you want to structure your business legally is one of the first and primary business decisions you will have to make. 3 min read updated on February 01, 2023
Updated November 9, 2020:
S Corp vs. LLC vs. Sole Proprietorship
Knowing the differences between Scorp vs. LLC vs. sole proprietorship can be helpful if you are considering one of these types of legal structures. There are many different ways to legally register your business. Some of the most common business structures include S corporations, limited liability companies (LLCs), and sole proprietorships.
What to Know Before You Begin
Deciding how you want to structure your business legally is one of the first and primary business decisions you will have to make. Depending on which type of business structure you choose, there are different levels of protection safeguarding your personal assets and shielding you from personal liability. There are also significant tax implications for each type of business structure.
There are several factors that you should take into consideration when making this decision, such as:
- The type of industry you are in.
- How many owners are involved.
- The size of your business.
One of the responsibilities of a business owner is to do his or her due diligence. This means you should objectively analyze the advantages and disadvantages of each business structure and make an informed decision that will be best for the business.
What Is a Sole Proprietorship?
Sole proprietorships are one of the most common forms of a business structure because they are simple to form and are a very cost-effective way of legally organizing your business. A sole proprietorship means just that — a business with one owner. If there is more than one owner, you will not be able to qualify for a sole proprietorship. The sole proprietorship and the owner will be legally considered the same entity.
To form a sole proprietorship, no legal documents are required, and the business does not even need to develop articles of organization, bylaws, or annual filings (except for the owner’s personal tax returns). However, states or municipalities may require the sole proprietorship to obtain relevant licenses or permits.
Some of the tax benefits of forming a sole proprietorship are that the business files its taxes as an individual, receives a pass-through tax, and can deduct business expenses from personal tax returns. The sole proprietorship does not have to pay payroll taxes and does not have to withhold income tax. However, you will have to pay a self-employment tax.
The most important difference between a sole proprietorship vs. LLC vs. S. corporation is that because the owner and the business are considered the same entity, there is no protection against personal liability. That means, if your business is involved in legal action and loses, you can be held personally liable, and all of your personal assets can be reached.
What Is a Limited Liability Company (LLC)?
A limited liability company is regulated under state law and must be registered in that state where it conducts its business transactions. An LLC provides a business owner or owners with the liability protections of a corporation and the tax benefits of a partnership. Under an LLC, the business owners and the business are considered two distinct entities. Thus, as opposed to a sole proprietorship where the owner can be held personally liable for the business’s actions, a business owner of an LLC is afforded greater protections that shield his or her personal assets from the reach of creditors.
For tax purposes, an LLC is not considered a separate entity from the owners, and the LLCs profits and losses are “passed through” to the LLCs members. This means that the members must report the business’s income and expenses on their personal tax returns.
What is an S Corporation?
An “S corporation” simply got its name from Subchapter S of the IRS code. It is a type of corporation that protects its shareholders from personal liability in the event that the corporation engages in some sort of misconduct. Unlike an LLC, however, an S corporation provides certain tax advantages that an LLC does not. For instance, LLC members are required to pay taxes on the business’s entire net income. Shareholders of an S corporation are only required to pay income tax on their share of wages.
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