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If you’re an entrepreneur, picking the right business structure is essential for success.
However, it’s normal to experience decision fatigue while you’re weighing your options.
Taking the time to research and consult with professionals can make your choice easier.
That’s the inspiration for this article: to provide you with an overview of sole proprietorships and S-corps that break them down in simpler terms.
Two popular business structures – S-corps and sole proprietorships – may be right for your business.
If you’re thinking about starting a business as a new or seasoned entrepreneur, this article aims to give you a head start.
We’ll define S-corps and sole proprietorships, talk about the differences between them, and guide you through your decision-making process along the way.
Learn the pros and cons of the 5 different business types to find the one that's right for you.
Key Takeaways
- Sole proprietorships are owned and operated by a single individual who is personally responsible for all business matters.
- S-Corps are a limited liability business structure that enables profits and losses to be distributed among shareholders, minus corporate taxation.
- Sole proprietorships and S corps are different in their ownership structures and taxation protocols.
- There are several benefits and drawbacks for each structure, such as complexity and liability.
- There is no perfect structure for a business; it’s better to choose one and master it.
Sole Proprietorship
Sole proprietorships are owned and operated by a single individual who is personally responsible for all business matters.
The head of a sole proprietorship is considered to be the same as the business, in terms of legal matters.
So, all debts and profits of the business become the responsibility of the owner.
Sole proprietors are the primary directors of the business and do not need to consider the input of others.
While checks and balances are essential for a well-formed business, it can be beneficial to form a business exactly the way that you envisioned it to be.
Additionally, all profits can be distributed as you see fit, which is not the same as in other business structures.
S Corporation
S corporations (or S-corps) are a limited liability business structure that enables profits and losses to be distributed among shareholders, minus corporate taxation.
S-corps must adhere to a more strict set of rules, such as all shareholders being U.S. citizens.
However, the taxation in this structure may be beneficial to your business. Pass-through taxation is one of the best parts of the S corp structure.
This type of taxation enables the profits and losses of a business to be filtered through the shareholders.
This structure can reduce the overall tax burden on a business. It is important to note that the IRS rules for taxation in an S-corp are stricter, such as shareholder meetings and complex bookkeeping.
What’s the difference between a sole proprietorship and S-corp?
| Sole Proprietorship | S Corporation |
|---|---|
| No legal separation between individual and business | Separate liability between owner and business |
| Uses a personal tax return to file | Taxes go through shareholders |
| Personal liability in terms of profits and losses | Shareholders have limited liability (asset protection) |
Benefits & Drawbacks
Sole Proprietorship
Simple structure with all decisions made by the owner
Tax benefits
Flexibility in management
Ability to have full control over all decisions
Limits on the amount or sources of funding available
Liability is fully assumed by the business owner
Assets are not protected
S Corporation
Limited liability/personal assets are not involved in the status of the business
Natural credibility (people trust S-corps)
Tax structure may allow for greater savings
More complex structure
Strict ownership regulations
Assets are not protected
IRS standards for pass-through taxation make taxation requirements more difficult to meet
How to choose between an S-corp and a sole proprietorship
Before you make your decision, here are some things to consider about yourself as an owner and the business at hand.
First, think about the liability that you are willing to assume for the lifetime of the business.
Will you be comfortable with having your assets tied to the success of your business?
Next, assess your tax options between both structures. As mentioned previously, S-corps may be subject to a lower tax rate, but filing as a sole proprietor may be simpler.
Finally, consider the organization’s goals. In particular, will you require funding or additional shareholders in the future?
Do you expect the business to grow in a significant way? What is the risk tolerance or management strategy of the business?
Overall, make sure that your decision is well-informed and considers all aspects of the business.
Sole proprietorship vs. S Corp: Which option is best for you?
You’ve reached the end of this article that compares sole proprietorship and S corp structures for businesses.
You are now hopefully more ready than ever to make this decision for your business.
In summary, choose a sole proprietorship if you want to have complete ownership over the business, and consider an S-corp if your business is growing substantially and you don’t want sole liability.
Whichever structure you choose, remember that many factors contribute to the health of a business.
As a thoughtful business owner who is interested in picking the right business structure, you’re already ahead!
FAQs
When should you switch from a sole proprietorship to an S Corp?
While there is no crystal ball that tells you when to switch, some indicators are increased profits, liability issues, and changing tax needs.
However, before making a change, it is advisable to discuss the pros and cons with the business and take the matter to a corporation professional.
What is the tax difference between S-corp and sole proprietorship?
The most important tax difference between an S-corp and a sole proprietorship is how the profits are taxed.
In an S-corp, pass-through taxation can lead to reductions in costs for the business. However, in a sole proprietorship, the personal income of the business owner is taxed.
Can a sole proprietor file as an S-corp?
Yes! However, the sole proprietor must submit a form called a 2553 (election by a small business corporation) with the IRS.
However, speak with an accountant or corporation professional before filing if you have additional questions or if you’re unsure about meeting the criteria to become an S-corp.
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Learn the pros and cons of the 5 different business types to find the one that's right for you.