How to Choose Your Business Entity: S Corp vs LLC vs Sole Proprietor

While it might not sound as fun as the creative part of running your business, understanding the difference between S Corp vs LLC vs Sole Prop is a smart move for ANY small business owner.

Today, we’ll explore the ins and outs of all 3 terms, so you can confidently decide the next move for your business! 

I see all you brave entrepreneurs out there trying to figure out the legal ins and outs of setting up your small business. 

You see terms all the time like LLC, S Corp, and sole proprietor, but you have questions like:

- Where in the world do I start when to get my business legalized?
- What is an S Corp vs LLC?
- What is an S Corp vs a sole proprietorship?
- Which business structure saves me the most money at tax time?

The right business structure can help you:

1. Hang on to more of your money during tax time,

2. Protect your personal assets, and 

3. Avoid legal headaches.

I’m Paige Griffith, head attorney at The Legal Paige. As a small business owner and experienced lawyer, I know how important it is to get simple legal answers to your business questions. 

I’ve provided legal resources to thousands of small business owners, from photographers to florists, to coaches, and course creators. I help you take the stress out of getting legally legit so your small business can thrive!

I’ll break down some key differences between S Corp vs LLC, plus other legal tips to help you set up your business legally from the start. 

For a quick summary of what you should know about an S corp vs. LLC vs sole proprietorship, download this 

FREE GUIDE: “How to Pick the Best Business Structure for You And Your Taxes!”

Jump to:

1. Starting a Business as a Sole Proprietor

2. Starting a Business as an LLC

3. A Quick Intro to S Corps

4. S Corp vs LLC Taxes: Differences and Benefits

5. The Legal Paige Take

S Corp vs LLC vs Sole Proprietorship: What’s the Difference?

There are three main business structures to know about when starting and growing your small business. 

These structures are:

1. Sole Proprietorship

2. Limited Liability Company (LLC)

3. And S-Corporation

Each type of entity has its own legal and tax benefits. Let’s get into some of the differences, including benefits and what it could mean for you and your business.

Starting a Business as a Sole Proprietor

You may not know this, but most small businesses start as a sole proprietorship, whether you choose it or not.

You don’t have to file or register with the state in order to become a sole proprietor (like you would if you wanted your business as an LLC). You are automatically a sole proprietor when you start your business. 

That’s because a sole proprietorship is NOT an actual business ‘entity.’ It’s just the default name for the business structure created when you do not register it through your state. 

It’s important to know that with a sole proprietorship, your business is not a separate entity. Rather, you as the business owner are personally responsible for it. That means YOU are responsible for debts, incurred costs, and other obligations of your business.

This also means taxes are simple. Since you and your business are one and the same, you can easily claim your business income/losses on your regular individual tax form/return rather than having to file separately. 

Downsides of a sole proprietor vs LLC:

- Your credit can be affected if you default on a loan.
- You can be personally liable for any lawsuits that can arise.
- Many banks will be less likely to provide loans to Sole proprietors vs LLC

There are no formalities to this type of business structure and no obligations on your end to maintain your legal status. It’s also the simplest way to file business taxes.

Being a sole proprietor is a great place to start if:

- You are the sole member of your company
- You are just beginning your business
- You don’t anticipate making a lot of money your first year
- You don’t have many employees or independent contractors
- You have little liabilities or risks involved in your services, and/or
- You consistently move to various states

If this sounds like you, a sole proprietorship is a good option for a short period of time. 

If you want to remain as a one-person business and are not facing liabilities or dealing with larger assets, you may choose to stay as a sole proprietor. This will allow you to not worry about registering with the state, stress over different tax forms, or think about yearly business entity filings. 

Starting a Business as an LLC

If you’re ready to make the jump from Sole Prop to LLC - congrats! Forming an LLC is when you know things are starting to feel really legit with your business. 

“LLC” stands for “limited liability company.” An LLC is formed by creating a company (a corporation) that acts as its own legal entity. 

An LLC has rights outside of any owners or agents of the company. So basically, when you form an LLC, it separates YOU and your personal money from YOUR BUSINESS and its money. This offers you ‘limited liability’ regarding business decisions (…hence the name). 

With an LLC vs a sole proprietorship, you’re not personally responsible for accidents or lawsuits related to your business.

For example, let’s say you’re a photographer working at a wedding. Someone trips on your off-camera flash cord and breaks their arm. In this case, your LLC (or your business insurance) could be responsible for paying for the harm. However, you wouldn’t have to dip into your personal savings because you have an LLC.

NOTE: This is also why it’s a good idea for photographers to have business insurance with general liability coverage. Your insurance will most likely pay out on these types of claims!

With an LLC, you get liability protection with very few formalities. (But remember, you must SEPARATE your business and personal income using a business bank account! Learn more about how to pay yourself legally in this short article or this YouTube video.)

For MOST people who own a business, the best thing you can do is set yourself up as an LLC. 

It’s likely time to make your business official with an LLC when:

- You’re taking on lots of clients,
- Make over about $10k in business income per year
- You want to expand to a couple employees
- Reach a larger group of customers that will involve more risk and liability.  

At this point in your business, it may be better to form an LLC instead to limit personal liability and separate debt from your personal assets. 

There are two types of LLC structures: manager-managed LLC and member-managed LLC. To find out which one is right for you, read more in this short article: Manager-Managed LLC vs. Member-Managed LLC.

Or listen on-the-go to The Legal Paige’s podcast episode: Episode 120: Filing An LLC Registration Yourself And Things To Know 

Does Your LLC Have to Be the State You Live In?

Once you’ve decided to form your business as a limited liability company, you’ll want to choose which state to register your company in. Generally, you’ll want to file your LLC in the U.S. state you plan on working and staying in permanently. 

If you travel a lot, this is generally the place you call your “home state” and plan to receive mail at in the future.

While you can change the state your business is registered in, it will take some paperwork. To avoid the additional work and costs, I HIGHLY suggest you take some time to think about where you’ll be registering your new LLC. 

Learn more about DIY LLC Registration in this article: “DIY LLC Registration: How to Register Your LLC in Your Home State.” 

If you’ve moved and  need to transfer your LLC to a different state, learn how here: “How to Move Your LLC to a new State”

💡 Want to set up an LLC but don’t know where to start? I’ve got you!

Browse our collection of Do-It-Yourself LLC Registration Guides to get your business registered in your specific state. You’ll find important links, definitions, and instructions on how to pay the filing fees, get a business bank account, and more.

GET A DIY LLC REGISTRATION GUIDE FOR YOUR STATE HERE 

I also walk you through 7 essential steps to establishing your very own LLC in this video: 7 Steps to Setting Up Your LLC. 

For the Serial Business Creator: Should You Put Multiple Brands Under One LLC or Keep Them Separate?

All right, so if you're on fire and just won't quit with one business—go you! 

You may be wondering: 

Should you keep them under the same legal business or separate them? 

You have a couple of options here:

1. Create separate LLCs for each business

2. Create one LLC and have all other businesses as DBAs underneath

This article walks you through some questions to help you decide the best way to handle multiple brands or businesses.

A Quick Intro to S Corps

At The Legal Paige, we help small business owners go from overwhelmed to secure in their legal practices. One of the most common questions I get is whether a small business should become an S Corporation. 

Choosing the right type of structure and tax designation for your small business is important. It’s good to figure this out early on to help your business thrive.

This may come as a bit of a shock but … an S-corporation is NOT a type of business formation or entity. It’s a tax designation. 

To be an S Corp, you must FIRST form your business as a limited liability company for legal purposes. 

From there, if you meet certain requirements, you can elect to designate your business as an S-Corporation for tax purposes. [1] 

To be an S Corp, the IRS requires that your corporation:

- has fewer than 100 shareholders who are all individuals, not corporations
- has only one class of stock available
- and is owned by U.S. citizens or resident aliens

You can be an S Corp even as a one-person business. In that scenario, you would just be the sole shareholder and the only employee of the S Corp.

Let’s look at the tax differences between an S corporation and LLC.

S Corp vs LLC Taxes: Differences and Benefits

Taxes for Single-member LLCs

Let’s talk tax time. For tax purposes, an LLC is what’s called a “pass-through entity.” This means that all the income and expenses from your LLC get reported on your personal income tax return.

How you file taxes with an LLC depends on if you are a single-member LLC or a partnership LLC. 

Single-member LLCs are taxed like sole proprietors. As a single-member LLC, the IRS requires you to:

- Report business income and expenses on your personal income tax return, and
- pay personal income tax on business profits, and
- Pay Social Security and Medicare taxes on business profits.

As a solopreneur, an LLC gives you liability protection with very few formalities.

Taxes for Partnership LLCs 

An LLC that has more than one member typically pays taxes like a partnership. The partnership must file a 1065 Form 1065, U.S. Return of Partnership Income. 

In addition, each owner must pay taxes on their lawful share of the profits on their personal income tax returns. It’s a little more work, but we say it’s worth it to protect your personal assets.

Tax season doesn’t have to be that scary! In this podcast episode, I break down more of how an LLC impacts your taxes and personal tax return: Episode 76: “How LLCs and Taxes Work Together”.

Taxes for S Corps

What difference does it make to be designated as an S Corp? Here are some main differences related to S Corp vs LLC taxes:

- Unlike an LLC, an S Corp must file a business tax return.
- With an S Corp, you as the owner have to put yourself on payroll.
- With an S Corp, you may receive dividends from any additional profits the business receives.
- You need to file a Form 1120-S by March 15th every year. 

The S Corp structure a bit more complexity to your tax season, but it may be a good move if you’re making more than six figures a year in net profit. 

That is because with an S Corp, you ONLY pay self-employment taxes (Social Security and Medicare) on your "reasonable salary." The business profits will not be taxed for self-employment purposes (but will still be taxed for all other purposes).

Here’s an example. Let’s say your wedding planning business profits $100,000 per year. 

Under an LLC, you’d need to pay self-employment taxes on the full $100,000. But maybe with an S Corp, you can pay yourself a salary of $70,000. The remaining $30,000 is considered a distribution and not subject to self-employment tax, potentially saving you thousands of dollars in taxes.

The additional business profits will not be taxed for self-employment purposes (but will still be taxed for all other state and federal income taxes). 

Think an S Corp might be for you? Watch this YouTube video to find out more: How to Become an S Corporation. 

I also share insights on how taxes work with an S Corp on this podcast episode: Episode 77: Understanding The Benefits Of S Corps and Taxes.

If you’re considering an S Corp, the important thing to consider is if the tax benefits are right for you. Every business is different, and determining the "reasonable salary" for you as a business owner can be tricky, so it's best to work with a certified CPA on this!

For a summary of these three business structures, download this free business structure guide from The Legal Paige. You can refer back to it to check that you’re making the best legal moves for your business and taxes.

The Legal Paige Take

1. It’s ok to start with a default sole proprietorship if:

- You are just starting your business and don't have many customers
- You don’t make much in terms of liabilities with past/current/future clients
- There aren’t major risks involved in your services
- You do not have employees

You’re automatically classified as a sole proprietor for tax purposes before registering your business.

2. You should absolutely consider registering your business as an LLC when:

- You see your sales going up and gaining customers
- You are considering expanding your business with employees or contractors
- There are more liabilities and risks involved in your business

An LLC protects your liability and assets.

3. Finally, an S corp might make sense for your business tax-wise if:

- Your business is growing to where you have a few employees
- You have a lot of profit margin (such as GROSS profit within the $50-100k range)
- You want to scale your business even more

At this point, it might make sense to speak with a CPA to see if it’s time to designate your LLC as an S-Corporation through the IRS.

FREE GUIDE: Legally Start a Business

Want to make sure you’re getting all the legal stuff right with your small business? This actionable step-by-step guide will get you legally legit in no time! 

Get tips from an experienced attorney on how to:

1. Choose a business name

2. Check that the name is available

3. Register your name with the state

4. Register your business entity

5. Apply for an employer identification number

6. Open a business bank account

7. Get your contracts in place

Download the FREE GUIDE: Legally Start a Business

Resources:

[1] IRS guidelines on choosing to designate your business as an S Corp for tax purposes: https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations 

[2] IRS guidelines on filing as a corporation or partnership: https://www.irs.gov/businesses/small-businesses-self-employed/llc-filing-as-a-corporation-or-partnership# 

[3] If you have more questions about what happens when you begin your small business I HIGHLY recommend visiting the SMALL BUSINESS ADMINISTRATION’S website to learn more about business structures and formation.