S Corporation Vs. Sole Proprietorship: Which Is Best For Your Business?

Corporation

Starting a business can be overwhelming, especially when you’re independently funding and running your company. You have to worry about everything from managing your team to promoting your product and more. However, one of the most important things you can do for yourself is to make these other tasks more accessible by choosing the best entity structure for your business.

This feature discusses S corp vs sole proprietorship so that you can decide which is better for your business. It also discusses some pros and cons of each structure, so you know what to expect if you choose one over the other. Continue reading to learn more.

 

S Corporation Basics

An S corporation is a separate legal entity, like a sole proprietorship or an LLC (Limited Liability Company). The authorities from the Internal Revenue Service (IRS) consider it to be a ‘pass-through’ entity, which means that the profits and losses of the company pass through to its shareholders. This is in contrast to C corporations, a type of business organization incorporated and taxed as a separate legal entity. C corps’ profits are taxed twice: once at the corporate level and again when distributed as dividends to shareholders.

To become an S corporation, you must file Form 2553 with the IRS alongside your regular business tax return (Form 1120S). Once approved, you’ll receive an EIN (Employment Identification Number) for your S corp. You’ll also receive permission from federal authorities to operate as such for up to one year (you can apply every year after that).

 

Pros and Cons of S Corporation

An S corporation has its pros and cons, just like any other business structure. If you’re wondering what the pros and cons of setting up an S corporation are, here are some of them:

  • The pros of setting up an S corporation include a pass-through tax structure that shields your assets from liability and the ability to deduct business expenses on your income taxes. 
  • Besides, an S corporation has more limited liability than a regular corporation. This means its owners (shareholders) aren’t liable for certain debts or liabilities of the business. 
  • The cons of setting up an S corporation include limits on who can own one. This type of business structure is only available to individuals and not corporations or partnerships. 
  • Another biggest con of operating as an S corporation is that you can’t issue stock options or convertible bonds, or notes as part of your compensation plan. The reason is that the IRS will treat these instruments as dividends, which can be taxed in the hands of the recipient at a rate up to 39%.

 

Sole Proprietorship Basics

A sole proprietorship is the most accessible business structure to set up, making it a good choice if you’re just starting your entrepreneurial journey.

A sole proprietorship is a business owned and operated by a single person: you. The owner of a sole proprietorship can be an individual or a group of people in partnership with each other (such as two or more partners). Because the owners are personally liable for any debts or lawsuits involving their businesses, they may lose more than just their business assets if something goes wrong with the company.

 

Pros and Cons of Sole Proprietorship

One of the pros of a sole proprietorship is that it’s easy to set up. Suppose you’re a starter; it’s easier to start with a sole proprietorship. 

Another advantage of setting up a sole proprietorship is easy to access financing. It’s easier to obtain financing for a sole proprietorship than for other business forms, such as corporations.

The main disadvantage of setting up a sole proprietorship is that you’re the sole owner, and you have to take on all the responsibilities and liabilities. 

Another disadvantage is that if something happens to you (like getting sick or hurt), your business will be at risk of closing down since there’s no one else who can step in and run it while you recover or heal from your injuries.

There are also some legal requirements such as registering with state agencies like a secretary of state office or local tax collector office so they can collect information such as names, addresses, and other data about the company’s operations.

 

S Corporation Vs. Sole Proprietorship: Which Is Best For Your Business

For many small businesses, the S corporation is the better choice. It protects your assets from creditors and allows you to avoid double taxation. If you’re planning to start a business with limited liability, then an S corp may be what you’re looking for.

If your company has high levels of liability or carries significant debt, the S corp may not be suitable for you. Because shareholders are personally responsible for any debts incurred by their companies (unlike LLCs and C corps), they might get wiped out in bankruptcy if something goes wrong.

For this reason alone, an S corp works better as a startup than a mature company (though there are other reasons why mature businesses should also consider switching).

If you’re thinking about starting a business, you may want to consider becoming an S corporation or a sole proprietor.

You can choose to be an S corporation entity or a sole proprietor. Both structures have pros and cons, so it’s essential to weigh your options carefully before deciding which one is best for you.

When deciding on the proper business structure for your company, consider what type of business you want to operate (for example, whether it’ll focus on manufacturing or retail), how much money you plan to make each year and what size team you’ll need. 

You’ll also want to think about how much time and effort you’re willing to put into running your company, and this may influence whether an S corporation or sole proprietorship is suitable for you.

 

Conclusion

If you’re deciding which business entity structure to use, consider consulting with certified public accountants. They can help you determine your business’s current and future needs. Also, they can provide advice and guidance as you make important decisions about protecting your assets while maximizing profits.