Sole Proprietorship vs Corporation: Everything You Need to Know
Picking between a sole proprietorship vs. corporation is an extremely important decision. 3 min read
Picking between a sole proprietorship vs. corporation is an extremely important decision. While sole proprietorships are easier and more affordable to establish, they don't provide the robust personal liability protections you can receive from a corporation.
Choosing the Right Business Entity
There is almost no more important decision than picking the business entity type for your company. The entity type that you choose can determine:
- Whether your business will succeed or fail
- If your personal assets will be shielded from liability
- What taxes you will need to pay
There is no entity type that fits every business, which is why this decision can be so difficult. Factors that influence the entity you choose include your business's locations, its industry, how many owners there are, and your strategy for one day leaving your business. You must impartially consider the strengths and weaknesses of each entity type so that you pick the right option for your business.
With some business entities, your personal assets, including your bank account, may be at risk from company debts, and with other entity types, your tax burden will be significantly greater.
The most common type of business entity is a sole proprietorship. It is also the easiest entity to form. A sole proprietorship has only one owner who is not legally distinct from their business. Sole proprietorships provide beneficial taxation and can be set up very easily, which are the two main benefits of this entity type. The drawback of a sole proprietorship is that the business's owner's personal assets can be pursued if the debts of the business are not fulfilled.
A partnership is an entity type that can have two or more people and whose main purpose is earning a profit. Forming a partnership is fairly simple, and your upfront costs should be relatively low. Every partner will contribute something to the business, whether their skills, cash, or labor. As with a sole proprietorship, the advantages of a partnership are affordable taxes and ease of formation. However, also like a sole proprietorship, partners can be held personally liable for business debts. Also, it's common for partners to disagree on important issues, which can result in time-consuming and expensive lawsuits. To avoid disagreements that result in lawsuits, you should consider writing a partnership agreement.
One of the newest, most popular types of business entity is a limited liability company (LLC). LLCs are governed by state not federal law, and the owners of the LLC will need to decide how the company will be treated for tax purposes. LLCs are an extremely flexible and practical business entity type. With an LLC, you will have strong personal liability protections such as corporations and beneficial taxes like a partnership. A drawback, however, is that an LLC can be disbanded if an owner dies or leaves the company. If you ever want offer company stocks publicly, you should consider forming a C Corporation.
C Corporations are entities that are legally distinct from their shareholders, which protects the personal assets of these shareholders from liability. If you choose to form a C Corp, you should be aware that your company will be subject to double taxation. Profits of a C corporation are taxed twice, once at the corporate level and again on the individual tax returns of shareholders. It's also important to remember that C Corporations must follow corporate formalities, and if they fail to do so, shareholder's liability protections can be at risk.
Those operating a small business may want to form an S Corporation, a business entity type that provides significant tax relief. With an S Corporation, you'll have taxation benefits of a sole proprietorship and the personal protections of an LLC. Unfortunately, not every business will qualify for S Corp status. If a business has more than 100 shareholders, S Corp treatment is not possible. Also, like C Corporations, S Corporations must follow formalities, and ignoring these formalities will result in the loss of personal liability protections.
If your business has a single owner, you will need to decide whether to form a sole proprietorship or S Corporation. Most small business owners are sole proprietors. This is true even if they have not sought this legal status. If you do not incorporate as another entity type and are running your business on your own, your company is a sole proprietorship by default.
If you need help picking between a sole proprietorship vs. corporation, you can post your legal needs 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.