S Corporation vs. Sole Proprietorship: Which Is Right for You?

Many small business owners struggle to differentiate and decide between an S Corp vs. a sole proprietorship. It doesn't have to be complicated, though.

Ahead, we'll explain what an S Corporation and sole proprietor are and outline each one's benefits and drawbacks, so you can make an informed decision that works for you.

What Is an S Corporation?

An S Corporation is a type of pass-through business entity that allows income, losses, tax credits, and deductions to pass through to its shareholders. This eliminates the need to pay separate corporate taxes, a big reason why S Corps are so popular.

However, S Corps also have a lot of rules in terms of proper distributions, bylaws, and record keeping. So if you are going to choose this business entity type for your business, make sure to do your research.

What Is a Sole Proprietorship?

A sole proprietorship is a business that is not separate from its owner and is automatically created when you form a business but don't legally file an LLC or other entity.

A sole proprietorship's owner:

• Must be the sole owner
• Is in charge of paying the business' taxes
• Can be held personally responsible for its debts and liabilities
• Cannot separate their own assets and liabilities from those of the business

And although sole proprietorships can register a trade name, they are unable to sell stocks like corporations can.

In terms of popularity, sole proprietorships take the cake among U.S. entrepreneurs. In 2018, the IRS received over 27 million returns from sole proprietorships (up 3 million from a previous report in 2013).

S Corp vs. Sole Proprietor: A Breakdown

Judging by the number of corporations in the U.S. and the number of sole proprietorships, you'd think that sole proprietorships are the superior choice. However, the issue of S Corporations vs. sole proprietorships isn't that simple.

In reality, the benefits of an S Corporation vs. those of a sole proprietorship vary depending on your unique wants and needs.

Advantages of S Corporations

S Corps are home to a variety of benefits that might make it an appealing option for budding business owners, such as:

• Robust protection from personal liability
• No double taxation — meaning you won't have to pay federal corporate tax
• Lower self-employment tax
• It's easy to transfer ownership to another shareholder

Advantages of a Sole Proprietorship

There's a reason sole props are so popular — they are really easy to start! Other benefits include:

• Inexpensive to start with no formal action required
• Straightforward taxation — the business's income is viewed as your personal income, so it's taxed as such
• Complete control over the business

Disadvantages of S Corporations

If you are considering creating an S Corp, keep in mind these potential drawbacks before you make anything official:

• Cannot offer more than one class of stock
• Shareholders are limited to 100
• More extensive record-keeping and reporting
• Increased regulatory oversight from state and federal organizations

Disadvantages of Sole Proprietorship

Sole proprietorships aren't without their faults, either. Their most significant disadvantages include:

• Full and unlimited personal liability — if your business goes into debt or gets into legal trouble, then so do you.
• Considerable difficulty raising capital from investors and obtaining loans from banks.
• Complete and total personal responsibility for any costly mistakes or overlooked details.

What Is the Tax Difference Between S Corp and Sole Proprietor?

The main tax difference between sole proprietors and S Corps has to do with your taxable income. As a sole proprietor, you'll be required to pay income taxes on all income your business makes. But if you file as an S Corp, you will only be responsible for taxes on your set salary (hint: no federal corporate tax).

Which Is Better: S Corporation or Sole Proprietorship?

In the end, an S Corporation may be better than a sole proprietorship if you have a large company and wish to limit your personal liability, want to avoid double taxation, want to raise capital, or want to be able to issue a specific type of stock.

However, what's right for you will be dependent on your business's unique needs. For example, if you are starting up a small business where you don't plan to hire employees and don't need liability protection, a sole proprietorship might be the best fit.

Still unsure which business structure you should choose? Take our business entity quiz to find out in just a few minutes. And when you're ready, Bizee can help you form your new S Corp and get up and running in no time.