Comparing Business Structures: Sole Proprietorship vs. LLC vs. S Corp
When you’re ready to turn your business idea into reality, one of the first major decisions you need to make is choosing a legal structure. This critical choice lays the foundation for your company’s growth trajectory. The right entity can provide benefits like liability protection, tax savings, and operational simplicity. Whereas the wrong structure can saddle you with burdens that hold your business back.
With so much riding on this pick, it pays to understand how sole proprietorships, limited liability companies (LLCs), and S corporations differ. In this comprehensive guide, we’ll compare and contrast these three most common small business structures. You’ll discover the pros and cons of each when it comes to taxation, liability exposure, management flexibility, and more.
Sole Proprietorship: The Simplest Structure
A sole proprietorship is the simplest and most common structure for small businesses. It’s not a separate legal entity – it simply refers to a company that is owned and run by one individual. The sole proprietor reports business income or losses on their personal tax return and does not have to register the business with the state.
Complete Ownership and Control
A major advantage of a sole proprietorship is that the owner retains complete control over the business. There is no board of directors or partners to consult – the proprietor can make decisions independently. The owner also receives all the profits directly rather than sharing with partners or shareholders.
Sole proprietors enjoy simplicity when it comes to startup costs and paperwork. You avoid the legal fees and filings associated with creating an LLC or corporation. The administrative side is easy as well, with minimal record-keeping requirements outside of your tax return.
Unlimited Personal Liability
The flip side is that sole proprietorships offer no liability protection. The owner is personally responsible for all business debts and obligations. If the company is sued or can’t pay creditors, the proprietor’s house, car, and other assets could be seized. Additionally, it can be difficult to raise investment capital when there is an unlimited liability risk for potential backers.
So, while the freedom of sole proprietorship is appealing, the lack of protection places your personal assets in jeopardy. This downside leads many business owners to ultimately form an LLC or corporation.
LLC: The Liability Shield
The liability protection of a limited liability company (LLC) is the main reason this structure has become so popular in recent decades. LLCs limit the financial liability of owners to their investment in the company. Your personal assets are shielded from any business debts, lawsuits, or claims.
For example, if someone slips and falls in your retail store and decides to sue, they can only go after the LLC’s assets. Your home, retirement accounts, and other possessions are protected by the liability firewall.
Greater Credibility With Customers
Additionally, operating as an LLC conveys a level of credibility and professionalism that sole proprietors often lack. Customers may feel more confident signing contracts with your established LLC rather than doing business with you as an individual. This legitimacy can be helpful when building your brand identity.
Downside of Self-Employment Taxes
Unlike corporations, LLC income is subject to self-employment taxes of 15.3% rather than lower corporate payroll taxes. You may be able to reduce your self-employment tax obligation by paying yourself a “reasonable” salary and taking the remaining profits as distributions rather than salary. But overall, the taxes are higher than a corporation.
While forming an LLC does require more time and expense than a sole proprietorship, the liability protection will likely outweigh those costs. A business attorney can quickly handle all the necessary filings so you can focus on growing your business.
S Corporation: A Popular Hybrid Structure
An S corporation blends elements of traditional corporations with tax efficiencies of partnerships and sole proprietorships. To form an S corp, you first establish a standard C corporation – the most common corporate structure. Then, you elect “S corporation status” with the IRS to receive partnership-style pass-through taxation.
This election allows income to be taxed at individual tax rates rather than the higher corporate tax rates. The overall tax burden is often lower with an S corp structure.
Limited Liability Protection
Like an LLC, forming an S corp will shield your personal assets from any business liabilities. Creditors cannot seize your bank accounts, investments, or possessions to settle company debts.
Tax Optimization Opportunities
One of the top advantages of an S corp is the ability to optimize how income is taxed. Owners can pay themselves a “reasonable” salary based on their role and industry standards. Any additional profits are then distributed to shareholders as dividends, which are not subject to payroll taxes like salaries.
For example, as the sole owner, you may pay yourself a $75,000 salary and take another $100,000 as a tax-free dividend distribution. This could add up to thousands in payroll tax savings compared to filing as a sole proprietor or LLC.
More Complex Than an LLC
S corps do come with more administrative complexity related to record-keeping, annual shareholder meetings, corporate minutes, and director requirements. There are also ownership limitations – S corps can only have 100 shareholders. So, if attracting investors is a priority, an LLC may be a better fit.
How to Determine the Best Structure for Your Needs
As you can see, each type of entity has pros and cons in areas like taxation, liability protection, and operational complexity. The right choice depends on the unique aspects of your business. Important factors to consider include:
- Funding plans – Will you need to attract investment capital? An LLC or S corp limits investor liability.
- Industry risks – High liability industries like healthcare tend to favor LLCs or S corps.
- Compliance burden – S corps have more record-keeping and reporting requirements.
- Profit/loss potential – Sole proprietors benefit from pass-through tax simplicity with large losses.
- Number of owners – S corps are limited to 100 shareholders.
- Long-term goals – Your ideal structure may change as the business grows.
The legal team at The Browne Firm has deep experience advising clients on entity selection based on these variables. If you’re ready to start your business journey on the right foot, reach out today to schedule a consultation. We’ll ensure you choose the optimal structure for your goals and maximize the benefits.
How We Can Help You Pick the Right Structure
Selecting a business structure is complex, with legal and tax implications. Our experienced business formation attorneys want to help ensure you choose the right structure so your company can thrive. We’ll take the time to understand your business model, goals, and risk factors. Then, we’ll clearly explain the pros and cons of each structure for your situation.
With over a decade of advising New York companies, we stay up to date on ever-changing regulations. We’ll help you navigate legal requirements like permits, licenses, and filings. Our team will also optimize taxes and liability protection. And we’ll provide ongoing counsel as your business evolves so you can focus on growth.
We Are Ready to Help You Choose the Right Business Structure
Starting a business involves complex decisions, but you don’t have to figure it all out alone. The Browne Firm has extensive experience advising small business owners like you on selecting the optimal legal structure. We take a personalized approach to understand your unique business model, growth plans, industry risks, and other factors. Then, we advise you to form the right entity to help you succeed.
Our law firm stays up to date on the latest regulations affecting New York businesses so we can steer you through legal requirements. We want to help you hit the ground running and build a company positioned for growth.
Don’t leave anything to chance – contact us today to schedule your consultation. A skilled business lawyer is ready to help you make informed decisions and start your business journey off on the right foot.