Sole Proprietorship vs S Corporation: Everything to Know
Sole proprietorship vs s corporation refers to the differences between a simple businesses structure and a highly complex entity.3 min read
2. Advantages and Disadvantages of Sole Proprietorship
3. Sole Proprietorships and Taxes
4. What is an S Corporation?
5. S Corporation Taxation
6. Setting up an S Corporation
Sole proprietorship vs s corporation refers to the differences between a simple businesses structure and a highly complex entity.
What is a Sole Proprietorship?
A new business is regarded as a sole proprietorship unless the individual responsible for the business forms it as another entity. Operating as a sole proprietorship means that you are trading under your own name. It is not necessary to draw up any legal paperwork, but depending on the location of your business, you might need to obtain a permit.
No distinction exists between the business owner and business, which means your own assets and business assets will be merged. However, if you are negligent and this negligence results in harm, you'll be held responsible. Therefore, taking out liability insurance is wise. As a sole proprietor, you are not considered a staff member of your business. You are self-employed or an owner of the business.
Advantages and Disadvantages of Sole Proprietorship
- An advantage is that, as a sole proprietor, the assets of the business belong to you.
- However, the main disadvantage is that your assets are not protected if someone sues you. If someone sues, your own money and property are at risk, as are your business assets.
- Many individuals opt for sole proprietorship because it's easy and inexpensive. It also means that you don't have to make any changes –- new businesses are sole proprietorships by default.
- In addition, there is no need to submit a separate tax return.
- Both business earnings and expenses are listed on your own tax return, alongside any additional earnings you make from other ventures or expenses you may have.
- A sole proprietorship is ideal for individuals who have a money-making hobby. For example, selling homemade products online as a side business is a perfect example of a sole proprietorship.
Sole Proprietorships and Taxes
- The tax rate is comparable to the rate that you pay when working as an employee.
- Similar to a single-member LLC, a sole proprietorship enables you to file taxes in a more efficient way. A sole proprietorship is regarded as a “disregarded entity” by the IRS, so business earnings are listed on the owner's personal tax return or Form 1040, rather than separately.
- When filing taxes, sole proprietors use Schedule C, Profit or Loss forms, and a Form 1040.
- Sole proprietors could also be entitled to a 20 percent income tax cut that is given to pass-through businesses under the Tax Cuts and Jobs Act.
- The business owner is in charge of retaining or submitting taxes, and this covers self-employment and approximate taxes.
What is an S Corporation?
An S Corporation is the most complex and costly business entity to establish. In contrast to a sole proprietorship or LLC, S Corps are not required to pay taxes on all business earnings. Even if a business has just one owner, it can still be structured as a corporation. In this case, the owner would act as the sole shareholder, president, and director.
Following an application to the IRS to be regarded as an S Corporation, an S Corporation is then treated as a pass-through organization for federal tax reasons. S Corps are only required to pay taxes on the earnings the owner pays themselves. According to the IRS, you must subtract a “reasonable” salary for your work.
S Corporation Taxation
Suppose your business earns $100,000 in revenue in one year. If you're a sole proprietorship or LLC, you'll be required to submit self-employment taxes on the entire amount of that revenue. However, if you are running an S Corp and you take a salary of $50,000, you would then only be required to pay self-employment tax on the $50,000 salary. The remaining $50,000 is only subject to standard taxes.
Setting up an S Corporation
- Establishing an S Corporation involves submitting Articles of Incorporation to the Secretary of State or relevant government official.
- An S Corporation distributes stock and is run as a corporation with directors, executives, and shareholders.
- An advantage of an S Corp is that a shareholder's own assets, such as personal finances, are protected in the case of the business being sued.
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