Sole Prop, LLC, S-Corp, Oh My!(Choosing the Right Business Entity)

Is your business set up in the best way for taxes and growth? The structure you choose – sole proprietorship, LLC, S corporation, etc. – affects how much tax you pay, your personal legal risk, and even how your business can expand. There’s no one-size-fits-all answer; the “right” entity depends on your specific situation. Let’s demystify the main options without getting lost in legalese.

Sole Proprietorship – Simplicity at a Cost - Most self-employed folks start here by default. It’s you, doing business as yourself. Easiest setup (no separate entity to form). Tax-wise, you report business income and expenses on Schedule C of your personal return. Downside: no liability protection – your personal assets are on the line for business debts. And all profits are subject to self-employment tax. It’s simple, but as you grow, you might outgrow the sole prop model.

Limited Liability Company (LLC) – Protection with Flexibility - An LLC is a popular choice for the personal liability protection it provides. Formed under state law, it shields your personal assets from business lawsuits or debts. Tax-wise: A single-member LLC is disregarded by default – you still file like a sole proprietor (Schedule C) and nothing changes from a tax perspective​. A multi-member LLC defaults to a partnership (filing Form 1065 and K-1s to owners). LLCs don’t save taxes on their own (you still pay self-employment tax on profits​, but they give you legal protection and flexibility – you can later elect to have your LLC taxed as an S-corp or C-corp if needed.

S Corporation – Tax Efficiency for the Established Business - An S-corp is actually a corporation that has elected a special tax status with the IRS. It blends some corporate benefits with pass-through taxation. The S-corp does not pay income tax itself; profits pass through to owners’ personal returns (like an LLC/partnership). The big tax advantage: owners who work in the business are paid a salary (which is subject to payroll taxes), but profits beyond the salary are not subject to self-employment tax​. This can save a chunk of money as profits grow. Example: Your S-corp nets $100k. You pay yourself a $50k salary (incurring Social Security/Medicare tax on that), and the other $50k is a distribution not hit by SE tax. Caution: That salary must be reasonable for your role – the IRS watches S-corps for owners taking unrealistically low salaries just to dodge taxes. Also, S-corps involve more paperwork (payroll, corporate filings) and possibly state corporation taxes or fees. But for many thriving small businesses, the tax savings outweigh the costs.

C Corporation – Big Business Features (Rarely Needed for Small Biz) - A C-corp is the standard corporation. It’s a separate taxpayer, paying corporate income tax (21% federal rate currently). If you as the owner take profits out as dividends, those get taxed again on your personal return – the infamous “double taxation.” Why would anyone choose C-corp? It can make sense if you plan to retain earnings to scale up (profits taxed at 21% could be lower than your personal rate) or seek investors/VC funding (investors often prefer buying shares in a corporation). C-corps also allow certain fringe benefits (like better retirement plan options, medical reimbursement plans) that owner-employees can enjoy. For a typical small business with a single owner, C-corp is usually not the go-to choice due to the double tax, but it’s there as an option in specific scenarios.

Partnership (including multi-member LLC taxed as partnership) – If you start a business with others without incorporating, you have a partnership. It files an information return and passes through income to partners. Partners pay tax on their share and generally pay self-employment tax on their earnings from the partnership. Partnerships offer flexibility in allocating profits and are relatively simple to run, but like sole props, partners have personal liability (unless you’re an LLP or LLC). Often, an LLC is used to structure partnerships to add liability protection.

So, which entity is best for you? It truly depends on factors like your income level, risk exposure, plans for adding partners or investors, and desire for simplicity vs. tax savings​. Many start as sole props or LLCs and later switch to S-corps as profits rise. Others need a C-corp from the get-go if they’re building a startup aiming for big investment.

Choosing correctly can save you thousands in taxes and protect your hard-earned assets. It’s worth a strategic review as your business evolves.

Get Expert Advice: Not sure if you should “LLC” or elect S-corp status? These decisions have long-term impacts. Consult with a Beaconshire Advisory Professional – we’ll evaluate your situation and handle any filings to change your business entity if it benefits you. Set up a meeting to ensure your business is set up for success, both tax-wise and legally.