Learning about sole proprietorship vs. S Corp taxes is the best way to decide which business structure will provide you with the most beneficial tax treatment. 

Sole Proprietorship

If you are in business by yourself, then you are likely a sole proprietor. You may have even achieved sole proprietor status without even realizing it. A sole proprietorship is simply a business owned and operated by a single person that has not been incorporated or formed as a limited liability company. While your city, county, or state might require you to obtain a license or permit, there is generally no legal paperwork required to establish your sole proprietorship. You can use any name you wish for your sole proprietorship as long as no other business has already claimed your desired name.

Sole proprietorships file individual taxes. To file your taxes correctly, you will use:

  • A 1040 Form
  • A Schedule C form, Profit or Loss from Business

Withholding and paying required taxes is the responsibility of the sole proprietor. This includes self-employment taxes and estimated taxes.

The primary drawback of a sole proprietorship is that you and your business are not separate for legal purposes, which means you may be exposed to a great deal of personal liability. If your business is involved in a lawsuit and loses, your personal assets may be included in the decision. Corporations, general partnerships, limited liability companies, limited liability partnerships all provide more liability protections than sole proprietorships.

When it's time to file your annual taxes, you and your business will be considered the same entity if you established a sole proprietorship. Sole proprietorships do not file business tax returns or pay business taxes. Losses and profits of your sole proprietorship will be reported on your individual return. You should also be sure that you're adding the profits of your business to any other income you have earned. If you have interest income, for example, you would add your business profits to this income and then the total income will be taxed.

Sole proprietors are not employed by their business. Because a sole proprietor is not an employee, payroll and income taxes do not need to be withheld. Sole proprietorships also have no need to file an employment tax return pay unemployment taxes at the federal or state level. However, sole proprietorships are required to pay taxes for Social Security and Medicare. 

S Corporation

It is possible to organize a business as a corporation even if it has only one owner. If you choose this structure, you would be the sole:

  • Shareholder
  • Director
  • President

It is very common for a corporation to have a single owner. After you have taken the necessary steps to form your corporation, you can file a form with the IRS so that you will be treated as an S Corporation for taxation. The shareholders of an S Corporation will have limited personal liability. This will, in theory, protect their assets if the corporation's debts are unpaid and a lawsuit occurs. However, in S Corporations with a single member, it is common to personally guarantee business debts, which can reduce the liability protection.

More beneficial taxation is the primary reason you would choose to form an S Corporation. S Corporations are a type of pass-through entity. This means that corporate losses and profits are passed to the business owner, who will report this information on their tax return. There is very little difference between the income taxes paid and available deductions for S Corporations and sole proprietorships. However, S Corporations are very advantageous in terms of Medicare and Social Security taxes.

All profits of a sole proprietorship can be taxed for Social Security and Medicare. Depending on your organization, your S Corporation may not be subject to these taxes.

When you are treated as an S Corporation for tax purposes, it's possible to remove money from your company without needing to paying any Medicare taxes or Social Security taxes. The reason for this is that S Corporation dividends, or distributions, are not taxed. Your Social Security and Medicare taxes will decrease the larger your distributions. If you want to reduce your Medicare and Social Security taxes, an S Corporation is the only business entity that you should choose. It is this tax reduction that makes S Corporations extremely popular with small business owners.

If you need help understanding sole proprietorship vs. S Corp taxes, 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.