1. What is an S corporation?
2. S Corporation Advantages
3. What is a Sole Proprietorship?
4. S Corporation vs. Sole Proprietorship

Comparing an S corp vs. sole proprietorship is common practice for entrepreneurs. Which structure makes the most sense for your unique business will depend on a number of factors. There are advantages and disadvantages to both. Understanding the structure, advantages, and paperwork involved in founding an S corporation versus a sole proprietorship will help you decide which business model to follow.

What is an S corporation?

An S corporation is a corporation treated as a pass-through entity under federal tax rules and is elected through the Internal Revenue Service (IRS). S corporations don't pay taxes at the corporate level. Instead, profits and losses are passed through to shareholders who report these on their personal income tax returns. In this way, the business avoids "double taxation".

To form an S corporation, business owners follow a process similar to the one used to establish an ordinary C corporation. The owner or owners must file an Article of Incorporation with the Secretary of State or similar agency in the state where they plan to operate their business. 

An S corporation is governed in the same way as a standard C corporation (C corp). Like a C corp, an S corp provides stock and is subject to oversight by a board of directors and officers. S corp business owners have the same liability protection as shareholders of a regular corporation. This means S corp shareholders' personal assets can't be taken away to meet business liabilities.

S Corporation Advantages

Running your business as an S corp has advantages, which can outnumber the perceived disadvantages of this more structured business model:

  • Pass-through Taxation. Federal taxes are not settled at the corporate level. All business profits or losses are "passed through" to the shareholders who pay taxes at the personal rate. Losses for the business can mean less income on shareholders' tax returns.
  • Tax-favorable characterization of income. Shareholders of an S corporation can also be employed by the company. This means that they are allowed to receive compensation and other benefits while also enjoying tax-free dividends and other distributions as part of their investment in the company.
  • Easy transfer of ownership. For some business types like an LLC or partnership, transferring ownership of more than 50 percent of the business can result in termination of the business. For an S corporation, it is easier to transfer ownership without adverse tax consequences or adhering to complicated accounting guidelines.
  • Protected Assets. Shareholders' assets are protected because shareholders are not responsible for company debts and liabilities. Creditors can't go after shareholders' personal assets to pay business debts. Under the sole proprietorship or partnership structure, the business owner and the business itself are considered the same entity, which means personal assets are subject to seizure.
  • Heightened Credibility. Having S corporation status can build credibility. Potential customers and vendors perceive S corp status as the owners' formal commitment to their business.

What is a Sole Proprietorship?

A sole proprietorship is a business entity owned by you and legally doing business under your name. It is the simplest business structure because you're working for your own company. Most businesses start as sole proprietorships and are restructured later on. 

As a sole proprietor, there is no separation between your personal assets and your business assets. One of the advantages is that you own your business assets. On the other hand, this business structure comes with inherent risk since personal assets like savings and property are not protected in the event of a lawsuit against your business.

In general, starting a sole proprietorship is easy because only basic documents like licenses and permits are needed to legalize your business. It is one of the easiest and least expensive business types to start.

S Corporation vs. Sole Proprietorship

Starting a business requires you to make hundreds of decisions. Deciding how to structure your business is one of the most important and immediate decisions you will have to make. Most business owners start their business as a sole proprietorship because it's less expensive up front and easier to start. Forming an S corporation may require more thought and planning, but it can offer incentives beyond what's possible with a sole proprietorship structure.

If you need help deciding whether an S corporation or sole proprietorship fits your business strategy, 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.