What are the differences between a sole proprietorship, an LLC, or an S corporation? Selecting the ideal organizational entity will help to protect your personal assets from any risks and liability that you may incur as your business develops.

Which Business Entity Is Best for Freelancing?

Many freelancers begin down the road of entrepreneurship by either working part-time or to gain supplemental income. As your income grows and the business turns into a full-time operation, it's important to think about establishing the company as a legal entity.

First-time business owners sometimes struggle with deciding on how to structure their business. Choosing an entity structure can be difficult and should be thoroughly researched before making a commitment. It can also be a somewhat complex endeavor as there are many tax and legal scenarios which need to be worked out.

The three most typical business structures are:

  1. Sole proprietorship
    • Doesn't provide protection against personal liability whatsoever
  2. Limited liability corporation (LLC)
    • Any income from the business is reported on your personal tax return
    • A single-member LLC provides a streamlined path to filing taxes and protects your personal assets from the creditors of the company
    • As a pass-through entity, you'll avoid paying both business and personal taxes on your income because it will all be reported on your personal income tax return
  3. S corporation
    • Also protects your personal assets from any business liabilities
    • Helps to prevent you from paying both corporate and personal taxes
    • Usually, the owner will receive salaries and benefits and pay dividends, all of which can be expensed against revenues

Please note that the following expenses are allowed to be deducted from revenues for both LLCs and S corps:

  • Pre-tax expenses
  • Travel
  • Computers
  • Advertising
  • Phone bills
  • Promotions
  • Health care premiums
  • Automotive
  • Home office

Differences Between an LLC, a Sole Proprietor & an S Corp

Establishing the ideal business structure is one of the first steps in starting a business. Most owners will choose either a sole proprietorship, an LLC, or an S corporation. Each structure has its own advantages and disadvantages. There are significant tax and legal implications for deciding on a business structure, so it's not a decision to take lightly.

In a sole proprietorship, the business owner runs the company. There is no legal paperwork that is required, but certain cities, counties, and states may request that you have specific licenses or permits. The IRS will always consider your business a sole proprietorship until the structure is changed to some other form.

Sole proprietorships may use their own name as the business name or change it to another name of their choosing. It is required that the business name is unique. Additionally, your business income and personal income are all reported on your personal tax return. The business' income and expenses are filed on the Schedule C, the Profit or Loss from Business form.

Sole proprietors are responsible for paying estimated taxes on a quarterly basis and withholding self-employment taxes. The most significant risk for a sole proprietorship is that if you lose a lawsuit, all of your personal assets may be at risk. Since a sole proprietorship is the default status for a new business, it tends to be simpler and cheaper on the frontend to establish.

Sole proprietorships are not required to create:

Recently, LLCs have gained popularity as a unique vehicle for reducing risk and liability and increasing flexibility in paying income taxes. LLCs are a separate legal entity from their owners and provide significant benefits, such as:

  • Limiting personal liability from the wrongful acts of employees or members
  • Easy to create
  • Personal savings and assets are protected from lawsuits

An S corp is similar to an LLC in that it is a separate legal entity from its owners and the profits and losses are passed through to the stockholders/members. Additionally, it provides significant benefits to the shareholders, such as:

  • Limiting personal liability from the wrongful acts of employees or members
  • Personal savings and assets are protected from lawsuits
  • Shareholders in an S corporation will only pay income taxes on the wage they receive
  • Dividends are taxed at a lower rate
  • Shareholders don't have to pay taxes on all of the revenues of the organization
  • Shareholders only need to pay personal income taxes on the salary they receive
  • Corporate profits are passed through to the shareholders' personal return, avoiding double taxation

If you need help determining the difference between a sole proprietorship, an LLC, or an S corporation, 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, Stripe, and Twilio.