Being a sole proprietor has advantages, but so does a corporation—so how do you know which is best? Here’s a closer look at sole proprietorship vs. corporation
When you’re starting a business, you have a ton of decisions to make.
You have to decide the name of the business, the purpose of the business, and who you’re going to sell to, and who’s going to build your website.
One of the most important decisions is how you should incorporate your business. This decision has a lot of implications, from how you’re taxed to legal liabilities. You want to know the advantages of a sole proprietorship vs. corporation so you can choose the right path for you.
Want to know more?
Read on to discover the differences between a sole proprietor and corporation.
What’s a Sole Proprietorship?
A sole proprietorship means that you are the business. It’s the most widely-used form of business because it’s the easiest to set up. There are about 23 million businesses set up as sole proprietors.
With this type of set-up, your personal and business finances are one and the same. You file your personal taxes and include a Schedule C Form, which lists your business income and expenses.
In a lot of cases, you don’t need to register a sole proprietorship with the secretary of state’s office. You don’t need to get the appropriate business licenses in order to operate, though.
You can have a sole proprietorship and own it jointly with your spouse. You and your spouse have complete control of the company and get all of the profits.
What Is a Corporation?
Do you remember when Mitt Romney famously said that “Corporations are people, too?” He was talking about the right of corporations to donate to elections campaigns. It can also help you understand what a corporation is.
Corporations are separate legal entities from their owners. Like people, corporations have their own tax returns, can take out a loan, enter into a contract, own property and equipment, and hire employees.
There are several different types of corporations. Each type has its own purpose and advantages for business owners.
A C-corporation is a good place to start if you plan on getting investors involved in your business right away. You can have an unlimited amount of shareholders and investors, which gives you a great opportunity to grow.
An S-Corp isn’t necessarily a business structure, but rather it defines how your income will be taxed. When you’re a sole-proprietorship, you’re responsible for paying the self-employment tax of 15.3% on all of your profits.
An S-Corp allows you to draw a salary from your LLC, which is taxed on your personal return as income. You and the corporation pay taxes, but not the self-employment tax because you’re taxed as an employee.
This may seem like a good way to avoid the self-employment tax, but you can often wind up spending more if your income is $50,000 a year or less.
Limited Liability Corporation
An LLC is another common form of business structure. In this setup, you have the legal protections that a corporation offers. Legally, your LLC is seen as a separate entity.
From a tax perspective, the IRS sees little difference between you and your LLC. You’re taxed as one and the same. You’re still responsible for the self-employment tax.
You could be an LLC and choose to be taxed as an S-corp. You want to get professional advice before you decide to take this route.
This is what you’re likely to consider when you’re comparing a sole proprietorship vs. corporation. A single-member LLC gives you some of the legal advantages of a corporation, but you’re still considered to be a sole-proprietorship from a tax perspective.
This option combines the best of being a sole-proprietorship with being a corporation for many freelancers and individually owned businesses.
Corporations are formed and registered through your secretary of state’s office. Learning how to become incorporated is complicated. There is a lot of paperwork involved and you have to form your operations agreement.
Sole Proprietorship vs. Corporation
Now that you know what a sole proprietorship and corporation is, how do they compare? Let’s take a look at the advantages and disadvantages.
The biggest difference between a sole proprietorship and a corporation is the amount of legal exposure you have.
In a sole proprietorship, you are legally one and the same as your business. If someone were to sue your business for any reason, they have the right to go after your personal assets. Your home, car, and personal property can be lost in the lawsuit.
As a corporation, you’re protected under the law. Remember, a corporation is a separate person. If someone decided to sue, they’d sue the corporation. Your personal assets will be protected.
Sole proprietorships are so common because they really don’t cost much money to set up. You hang your shingle, get a business license, and you’re on your way.
Corporations, including single-member LLCs, can cost a lot of money to set up. You can set them up on your own through the secretary of state’s office, but you don’t know all of the legal requirements.
At the very least, you’re looking at several hundred dollars to set up a corporation. Going through an attorney is the best way because you know it’s done right. They can cost about $1000 to get it done.
You often hear infuriating stories of giant corporations like Amazon that pay zero federal taxes. That is one advantage that corporations offer. You’ll have to pay some taxes. You’ll pay taxes as a corporation and on your personal taxes.
As a sole-proprietorship, you’re responsible for the self-employment tax and your income taxes on the profits of your business. Even if you made $6000 for the entire year, you’ll still have to pay the self-employment tax.
What’s the Best Choice for You?
As you can see, you have a big decision when you’re starting a business. There is a lot to consider when weighing a sole proprietorship vs. corporation.
You want to consult with an accountant and attorney before you make the decision to make sure you’re making a good choice.
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