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Pros and Cons of Sole Proprietorship, LLC and More

Nitty-Gritty Details, Incorporating, and Taxes

Sole Proprietorship, Limited Liability, or Corporation?

Ok, so you’ve done some research, picked a great name, web domain and phone number to back it up, but now it’s time to get legally recognized as a business.

Sole proprietorship, limited liability (LLC), or corporation (S or C)? These are all ways that the government can understand what sort of business you are so they can tax you accordingly.

These categories weren’t that meaningful before you wanted to start your own business, but now you’re scratching your head thinking about what they mean!

What is a Sole Proprietorship?

A sole proprietorship is when someone owns and runs a business by themselves. That business is unincorporated. If you decide to create an LLC instead, even by yourself, you no longer run a sole proprietorship.

This structure is the most simple and the easiest to understand. In order to form a sole proprietorship, you don’t need to take any formal action. If you remain the only owner, you are a sole proprietor as long as you are selling your services. For example, a freelancer writer who works alone is a sole proprietor.

When it comes to taxes, there is no differentiation between you and your business, so you are taxed as one. You just use a Schedule C and a Standard Form 1040.

Pros and Cons of Sole Proprietorships

If you’ve decided to take on this endeavor by yourself, a sole proprietorship is probably the way to go. The advantage? Complete control.

Unlike an LLC, there aren’t any complicated legal agreements involved that determine ownership. If you’re a sole proprietor, you can run the business however you want. Here are the advantages and disadvantages of a sole proprietorship:

The Pros The Cons

Complete control and flexibility to run the business as you see fit

Personally liable for all business debts, you’re all by yourself

Unlimited liability means creditors are more likely to extend credit if needed

Banks are reluctant to give loans due to higher turnover rates and usually smaller assets

You receive all business profits

Creditors can go after your personal property to satisfy a claim if your business assets aren’t enough

Smaller amounts of capital make for easier organization

Since the business relies on one person only, it is harder to raise capital on a long-term basis

What is an LLC (Limited Liability Corporation)?

A limited liability corporation, better known as an LLC, is a business structure that combines pass-through taxation (like in a partnership or sole proprietorship) with the limited liability of a corporation. An LLC is not a corporation—it is a legal form of a company that provides protection and limited liability to its owners. Basically, if a corporation and a sole proprietorship (or partnership) had a baby, they’d name it LLC.

Pros and Cons of LLC (Limited Liability Corporations)

With the limited liability characteristics of a corporation and the convenience of a flow-through income taxation (where the income of the business is filed as part of the owner’s personal income and not taxed separately), this option is suitable for multiple ownership circumstances. Here are the advantages and disadvantages of an LLC:

The Pros The Cons

You have the flexibility of being taxed as a sole proprietor, partnership, S corporation or C corporation.

As an LLC member, you cannot pay yourself wages.

Less paperwork and lower filing costs

High renewal fees or publication requirements can be pricey, depending on your state.

You can form an LLC with as little as one person, but you can also have an unlimited number of members.

Many states have a franchise or capital values tax on LLC’s, ranging from a flat fee to an amount based on the company’s revenue

Flow-through income taxation, keeping things simple

Investors may be more likely to put their money into a corporation, making it harder to raise financial capital

Members are protected from some (or sometimes all) liability if the company runs into legal issues or debts.

Unless you are running the LLC alone, the ownership of the business is spread across its members (this can also be a pro)

Members can receive revenues (and write off forfeitures) that are larger than their individual ownership percentage.

  

What is an S Corporation?

An S Corporation is a business entity that is federally taxed in a certain way. It is taxed as a pass-through entity by the IRS. Ah, that’s confusing. What does this really mean?

An S Corporation gives out stock and is treated much like a corporation. The owners of the S corporation are called shareholders and they are protected from liability just as they would be if they had an incorporated business. That means that if something bad happens to the business, the shareholder’s personal bank accounts cannot be tapped.

An S corporation is not the same as a sole proprietorship, but the two have similarities. Each shareholder is subject to their own tax rates, and there is no “double taxation,” which means that shareholders are not taxed on both the corporate and individual levels.

There are a lot of advantages to S corporations, especially if you change structure or transfer ownership.

S Corp Features

Potential Tax Savings. An S corp does not have to pay taxes like a corporation. Instead, individual shareholders report their earnings on their individual tax returns. Because the S Corp is not charged on the federal level, an S corp can result in significant tax savings.

Independent Business Life. The S corp is not like a sole proprietorship in that it operates separately from the owner or shareholders. Personal assets and business ones are separated when it comes to business liability.

Possibility to Combine Benefits of LLC with S Corp. You can request S Corp status for an existing LLC. You have to contact the IRS to make a special election, using Form 2553. The LLC is still legally an LLC, but when it comes to taxes, it will be treated as an S Corp.

S Corp Requirements

It would be great if every business qualified to become an S corporation, but the IRS does have a list of requirements. The IRS’ list is below:

The IRS has extensive information on how to become an S Corporation if you are interested. As usual, we recommend hiring a business lawyer or accountant to help you with filing, just to ensure that you’re making a sound decision for your business while following federal and state tax laws.

S Corp Advantages

S Corp Drawbacks

What is a C Corporation?

A C corporation is a business entity that is taxed separately from its owners. Businesses are incorporated differently in all 50 states. All C corps are required to issue financial statements.

What's the Difference Between a C Corporation and an S Corporation?

In a C corp, the business and owners are taxed completely separately. In an S corp, shareholders are individually taxed based on their shares.

C Corp Features

C corps have a lot of features that make them attractive to business owners, startup founders, and investors. Here are a few of the most notable:

C Corp Advantages

Owners are separate from legal liability so they’re not entirely responsible when faced with legal issues or debt. In general, it’s nice to have the business as a separate entity, so that owners are completely separate. Owners also have the ability to sell stock, which raises the likelihood of acquiring financial capital. A C corp has a well-established structure with clearly defined roles, accountabilities and agendas. Plus, employees have the option to buy stock at a fixed-in price, and receive stock benefits.

C Corp Requirements

C Corps have different requirements than other business entities. You have to fill out more paperwork. In fact, you’re required to hold formal shareholder meetings and take notes on them. You need to spend more time dealing with taxes and nitty-gritty details than for other business entities. The corporate tax forms can be so difficult to fill out that you may need to get a business accountant, though this is a good idea no matter what kind of business you have.

Pros and Cons of Corporations

A corporation is a business entity that is legally separate from its owners. It has the right to enter into contracts, take legal action against others, give and receive loans, own assets, hire workers and pay taxes.

One of the most significant things about a corporation is its limited liability. That is, shareholders have the right to participate in the profits through stocks and paid dividends, but are not held personally accountable for the company's debts or legal issues that may arise.

Remember that famous trial where the woman successfully sued McDonald’s for serving their coffee at too high a temperature? Good thing McDonald’s was incorporated!

The Pros The Cons

Owners are separate from legal liability so they’re not entirely responsible when faced with legal issues or debt.

The process is time consuming and expensive, lots of paperwork.

Ability to sell stock, which raises the likelihood of acquiring financial capital.

Tons of regulations, which make for very little flexibility.

Well established structure with clearly defined roles, accountabilities and agendas.

Possibility of double taxation (where both the corporation’s profits and stockholder’s paid dividends are taxed).

Employees have the option to buy stock at a fixed-in price, and receive stock benefits.

  

What About Partnerships?

In this context, a partnership is a business union in which two or more individuals manage and maintain their business. Unlike a corporation or LLC, a partnership requires no incorporation paperwork with the Federal government. Therefore, the three types of partnerships – general, limited or limited liability – are somewhat informal structures.

In a General Partnership, all owners (or general partners (GPs) are equally responsible for the debts of the business, each assuming unlimited liability.

The Pros The Cons

Flow-through income taxation for all partners

Each owner is equally responsible for debt and loss

Less expensive and less paperwork than incorporating or filing to become an LLC

Creditors can go after your personal property to satisfy a claim if your business assets aren’t enough

Partners can pool resources and share the financial obligation rather than facing it alone

Liable for debts and actions of your partner

No rigid, obligatory corporate structure

Limited capacity to raise money and attract investors

In a Limited Partnership, owners can take on the role of a limited partner (LP) who reports to a GP (there can be more than one) and therefore have less responsibility in the event of company debt or accountability. The GPs have managing power, but also take on all of the liability for partnership duties.

The Pros The Cons

LPs have no liability and still make a profit

LPs have no managerial power

GPs have total managerial power

GPs have total liability

Flow-through income taxation for all partners

More filing formalities than a general partnership

Less expensive than incorporating or filing to become an LLC

LPs can lose all of their limited liability if they take on any management roles

Safer and thus more attractive to some investors

  

A Limited Liability Partnership is for those who want to assume as little responsibility as possible across the entire partnership.

The Pros The Cons

Flow-through income taxation for all partners

Available only for specific occupations

Has the flexibility to choose what kind of management structure it wants because everyone can participate in management roles

Partners are personally responsible for their own or any of their employees’ negligence regarding creditors, proprietors, etc.

Less expensive and less paperwork than incorporating or filing to become an LLC

  

Choosing a State to Incorporate (It Matters Where You’re From)

Since taxes, prices and corporate laws are not the same in every state, it is important to consider your home state’s advantages and disadvantages when it comes to forming your business.

Some things to consider when you’re shopping for states:

If you’re on the fence, check out our blog post about the seven best states to incorporate.

Get Yourself a Tax ID and Understand Tax Implications

Once you’ve decided what kind of business entity you are going to be and where you want to incorporate, it’s time to get a tax ID number (also known as an Employer Identification Number, or EIN). This means the IRS will recognize you as a business and allow you to pay your state, federal and local taxes. Yay!

This service is free, so if you are being charged for applying, beware!

The best way to apply for a tax ID number is online through the IRS website. You’ll be asked a series of questions, and upon validation you’ll receive your official EIN.

But what forms do I fill out?

The tax forms you file will depend on the type of business entity you have chosen.

Try the Incorporation Wizard

It’s pretty difficult to choose which business structure is right for you. One of our favorite resources in BizFiling’s Incorporation Wizard, which allows you to input some information about your company to help determine what structure is right for you. Every business is different, which is why we highly recommend hiring an accountant or lawyer to help you make the decision that’s right for you. 

Resources We Find Helpful: