86.5% of nonemployer firms in the US are sole proprietorships, and 13.3% of small employer firms use this business structure. On the other hand, the numbers for S-corporations are 4.6% and 52.4% respectively. Based on these numbers, nonemployer firms favor sole proprietorships and small employer firms favor S-corporations.
But what does that mean for you if you want to start your own business? Which are the smarter choices for your situation? Find out more on the S corp vs sole proprietorship topic by reading on.
What’s an S Corporation?
Contrary to popular belief, an S corporation isn’t a business entity type. Instead, It’s an IRS tax election.
Limited liability companies (LLCs) and C corporations can opt for this tax election by filing Form 2553.
What’s a Sole Proprietorship?
A sole proprietorship is a business entity type and it basically describes entrepreneurship. It’s owned and operated by only yourself, and you are considered one and the same with the sole proprietorship. In other words, there’s no legal distinction between the two.
S Corp vs Sole Proprietorship
Now that you understand what an S corp and sole proprietorship are, it’s time to delve into their similarities and differences. This can help you make an informed decision when you start your entrepreneurship journey.
Ownership
S corps can have multiple shareholders who own the company; in fact, this number can go all the way up to 100. Shareholders can be individuals, certain trusts and estates, but not partnerships, corporations, or non-resident aliens.
As stated earlier, sole proprietorships are owned and operated by just one individual.
Liability
In an S corp, shareholders have limited liability. This means that their personal assets are generally protected from business debts and liabilities.
As for sole proprietorships, the owner is personally liable for all debts and obligations of the business. Your personal assets are at risk if the business faces lawsuits or can’t pay its debts.
Taxation
S corporations are pass-through entities for taxation purposes. This means that the corporation itself doesn’t pay federal income taxes. Instead, profits (and losses) are “passed through” to the shareholders’ personal tax returns and taxed at their individual tax rates, just like with an LLC. The owner won’t have to pay self-employment taxes, but will be subject to Social Security, Medicare, and Federal Insurance Contribution Act (FICA) taxes.
Income from a sole proprietorship is typically reported on the owner’s personal tax return with Form 1040. It’s subject to self-employment taxes.
Income
Because there can be multiple shareholders in an S corporation, income can be distributed in two ways. You can either pay dividends or salaries to the owners; the latter will incur the same tax liabilities as with a sole proprietorship.
Income is more simplified in a sole proprietorship. All the money goes to the owner, and they’re the ones responsible for paying taxes on it.
Control
You may have less freedom if you have an S corp. Shareholders have a say in major decisions, typically proportional to their ownership stake. In addition, day-to-day operations may be managed by officers and directors.
For complete control, choose a sole proprietorship. You have the final and only say in its operations.
Ease of Formation
Admittedly, forming an S corporation involves lots of paperwork and formalities when compared to a sole proprietorship. You’ll have to file articles of incorporation, adopt bylaws, hold initial and annual meetings, and issue stock.
On the other hand, sole proprietorships are easy and inexpensive to set up. There’s no formal registration required, although there may be local business license requirements involved.
What if You Have a Sole Proprietorship and Want to Be an S Corp?
In most cases, sole proprietorship is a terrible idea if you’re serious about your business. It’s too risky, and it has no real advantages. You’d be better off with an LLC, as it’s similar (you can run it as a single-owner LLC), but gives you more protection.
Another key point is that sole proprietorships can’t be S corps. So if you were wondering, “Is a sole proprietorship an S corp?” then the answer is “no.”
This means that you must change your sole proprietorship to either an LLC or a corporation. Whatever you choose, our business registration service will get you set up in no time. You can even speak to our knowledgeable agents to determine which business structure is right for you.
Choose the Right Business Structure for Your Situation
After reading this thorough S corp vs sole proprietorship guide, you should have a better picture of what each one is.
It can be tough to choose between a sole proprietorship and an S corp, but generally speaking, the latter is the wiser option. Forming an LLC gives you almost the same scenario as having a sole proprietorship, but you’re protected by limited liability. Plus, you can give an LLC the S corp tax election, so it’s a win-win situation all around.
Sign up for a Business Anywhere account if you want to form a business and reap S corp benefits. You can also enjoy other services, such as our online notary, virtual mailbox, and registered agent service.
