Sole Proprietor, LLC, or S Corp? Choosing Your Structure
A plain comparison of the common business structures, what each one changes about liability, taxes, and paperwork, and when an S corp election starts to make sense.
Few startup questions cause more late-night searching than this one. A friend swears by an LLC, an online ad pushes an S corp, and your cousin says none of it matters until you are bigger.
The good news: your choice is not permanent, and the basic trade-offs are easy to understand. It helps to know that two separate questions are hiding inside this decision. One is legal (who is responsible if something goes wrong?). The other is tax (how is the profit taxed?).
The main options
- 1
Sole proprietorship
The default when you start doing business alone. No filing to form it. You and the business are legally the same, and profit goes on your personal return via Schedule C.
- 2
Limited liability company (LLC)
A state-created entity that separates the business from you legally. A single-member LLC is taxed like a sole proprietor by default, so your tax return looks much the same.
- 3
S corporation
Not a separate kind of company, but a tax election made with IRS Form 2553 by a corporation or an LLC. Profit passes through to owners, and working owners are paid a salary through payroll.
| Sole proprietor | Single-member LLC | LLC taxed as S corp | |
|---|---|---|---|
| Personal liability | Unlimited | Generally limited | Generally limited |
| How profit is taxed | Your return; SE tax on all | Same as sole prop | Salary via payroll; rest as distributions |
| Paperwork | Minimal | State filing, annual report | Payroll, separate tax return |
| Typical cost | Lowest | State fees | State fees plus payroll and tax prep |
| Best fit | Testing an idea, low risk | Most new owners with some risk | Steady, solid profits |
What liability protection really means
Limited liability means that if the business is sued or cannot pay its debts, your personal home and savings are generally protected. It is a real benefit, especially if you work in customers' homes, serve food, or sign leases.
Protection has limits
An LLC does not protect you from your own negligence, and most lenders will ask you to personally guarantee business loans. Courts can also ignore the LLC if you mix personal and business money. That is one reason to separate your money from day one. Insurance still matters too.
How taxes differ
As a sole proprietor or default single-member LLC, you pay income tax plus 15.3% self-employment tax on 92.35% of your net profit, whether you take the money out or leave it in the business. Our lesson on self-employment taxes explains the math.
With an S corp election, you pay yourself a salary through payroll, and Social Security and Medicare apply to that salary. Remaining profit can come out as distributions, which are not subject to those payroll taxes. That is where the savings come from, and it is also why the IRS watches salaries closely.
Owner story
Marcus started as a sole proprietor with one van. When he hired his first helper and began working in larger homes, he formed an LLC and upgraded his liability insurance. Two years later, with profit steady above what he needed to live on, his accountant ran the numbers on an S corp election. The payroll tax savings more than covered the extra payroll and tax prep costs, so he elected S status for the next January.
Illustrative composite, not a real customer.
Myth or fact? Tap to flip
Quick check
Which statement about LLCs and S corps is accurate?
Words to know
- Limited liability
- Legal protection that generally keeps business debts and lawsuits from reaching your personal assets.
- S corp election
- A tax choice, made on Form 2553, that lets profit pass through to owners while working owners take a salary.
- Distribution
- Profit paid out to an owner that is not wages.
- Reasonable compensation
- The market-rate salary the IRS expects working S corp owners to pay themselves.
Finished reading?
Track your progress through Stage 1: Start.
Related lessons
Bookkeeping Basics: Systems That Save You at Tax Time
A simple weekly and monthly routine turns tax season from a shoebox scramble into a quick handoff.
Building a Cash Cushion for Your Business
How big your reserve should be, where to keep it, and a simple allocation habit that builds it without a windfall.
Employee or Contractor? Getting Classification Right
How the IRS and states decide who is an employee, and what it costs to get it wrong.