Sole proprietorship, LLC or S corp: the key differences

One of the first questions a new owner asks is whether to simply start working under their own name or set up a company. The answer depends on how much profit you expect, how many owners there are and how much risk the business carries. This guide lays out the main differences.

It is a general overview, not advice for your situation. Before you file anything, run the numbers with a CPA.

What is the basic difference between the three?

A sole proprietorship is the owner doing business directly. There is no separate legal entity, and the owner is personally responsible for the debts of the business.

An LLC is a separate entity formed with the state. An S corporation is different again: it is a federal tax election that an eligible corporation or LLC makes with the IRS. So the real comparison is often between a legal structure (sole proprietorship or LLC) and a tax treatment (default or S corporation).

How is each one taxed?

A sole proprietor reports business profit on Schedule C of their personal return and pays self-employment tax of 15.3% on net earnings, made up of Social Security up to the annual wage base and Medicare. A single-member LLC is treated the same way by default, and a multi-member LLC files a partnership return.

With an S corporation election, owners who work in the business are paid a reasonable salary through payroll, and the remaining profit passes through to their personal returns without self-employment tax. That can lower the total tax bill, but it also brings payroll filings and a separate Form 1120-S. Our estimated tax calculator gives a rough idea of what you may owe, and filing dates are covered in business tax return deadlines.

How do liability and risk change?

As a sole proprietor, business debts and lawsuits can reach your personal assets. An LLC is designed to keep the business's obligations with the business.

That separation is not absolute. Signing personally for business debts, your own professional mistakes and commingling personal and business money can all weaken it. Keeping a separate bank account and clean books is part of what makes the structure hold up.

What does setup and ongoing bookkeeping involve?

A sole proprietorship needs little more than local licenses and, if you hire or choose to, an EIN. An LLC requires a filing with the state, and formation fees and annual report requirements vary by state. An S corporation election is made on Form 2553 and adds payroll and a corporate return to the yearly routine.

Each step up in structure adds bookkeeping. We walk through the formation steps on our business formation page. If you later need to wind things down, see the closing a business checklist.

What should you ask before deciding?

This short list helps you prepare for the conversation:

• How many owners will there be?
• What profit do you expect in the first year?
• How much of the profit will stay in the business and how much will you take out?
• Do clients, landlords or lenders expect you to operate as an entity?
• Do you plan to raise money or bring in partners later?

Writing down the answers ties the choice of structure to real numbers instead of rules of thumb.