Which is Better S-Corp vs Sole Propriertorship

November 27, 2021

Which is Better S-Corp vs Sole Propriertorship

There are 23.6 MILLION sole proprietors in the United States… But only 7.4 MILLION S Corporations. The questions are: Why? What are the pros and the cons? S Corp VS Sole Proprietorship? Use this complete guide to find out.

You have an issue. S Corp VS Sole Proprietorship – Which do you choose? Lucky for you, we spent 4.5 days to break-it-down for you the BEST way possible. Ready? Let’s go!

Key Takeaways on Whether an S-Corp is Better vs Sole Proprietorship:

  • What is an S Corp: An S Corp is a tax classification for corporations, allowing income to pass through to shareholders and avoiding double taxation.
  • What Exactly is a Sole Proprietorship: A Sole Proprietorship is an unincorporated business with one owner who pays personal income tax on profits and is personally responsible for debts and liabilities.
  • Characteristics of an S Corp: S Corps are pass-through entities for tax purposes and can be applied to LLCs and partnerships as well.
  • S Corp Advantages:
  • Protected Assets: Personal assets are protected from business creditors.
  • Pass-Through Tax: Avoids double taxation at the corporate level.
  • Easy to Transfer Ownership: Ownership can be easily transferred, and the entity can exist indefinitely.
  • More Credibility/Professionalism: Offers enhanced credibility and professionalism.
  • S Corp Disadvantages:
  • More Expenses (Fees): Can be expensive due to state taxes and filing requirements.
  • More Formalities: Requires adherence to legal formalities like annual shareholder meetings.
  • More Work to Set-Up: Involves significant paperwork and effort to establish.
  • High IRS Scrutiny: IRS closely monitors reasonable salary payments to owners.
  • Sole Proprietor Advantages:
  • Easy Set-Up: No formal paperwork required to start.
  • No Corporate Tax: Only taxed once as a pass-through entity.
  • Easy Tax Set-Up: No need for an EIN in most cases.
  • Easy Banking: No separate business account required.
  • No Formalities: No legal formalities to follow.
  • Time Saver: Saves time as no registration or filing is needed.
  • Low Fees and Costs: No registration fees or annual maintenance fees.
  • Sole Proprietor Disadvantages:
  • No Liability Protection: Personal assets are at risk.
  • Less Credibility/Professionalism: May be perceived as less reliable or professional.
  • Harder to Sell Business: Difficult to transfer business ownership.

These takeaways provide a comprehensive comparison between S-Corps and Sole Proprietorships, highlighting their respective advantages and disadvantages in terms of legal structure, taxation, and operational implications.

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What is an S Corp?

(Listen up because we're only gonna say this once)

There is a type of legal entity called “corporations”. When becoming a corporation, there are 2 options of how to get taxed.

Meaning, the IRS has 2 tax statuses – through the classification of:

  • A “C Corporation” (C Corp).
  • An “S Corporation” (S Corp).

By default, the IRS considers a corporation to be a C Corp. In short, the difference between C corps and S Corps is their IRS tax status.

C Corporations pay taxes at the corporate level while S Corporations do NOT. Instead, an S Corp’s individual shareholders split up the income amongst each other and get taxed on their individual incomes, separately. Just ask the IRS, they’ll tell you exactly what we’re saying.

s corp vs sole proprietorship

This means that S Corps are “pass-through” entities.

“A pass-through / flow-through entity is a legal business entity that passes any income it makes directly to its owners, shareholders, or investors.”

A “C Corp” pays taxes both at the corporate level and at the personal level. In other words, a C Corp is “double taxed”.

“Double-taxation is when you pay income taxes 2x on the same source of income. Meaning, the entity pays taxes both on the business and personal levels.”

In short, an S Corp is not an entity of its own.

Simply put, it’s a tax classification for a corporation.

It is IMPORTANT to note.

Many times, the term S Corp can be applied to LLCs and partnerships. Meaning, the same way a standard S Corporation does NOT pay taxes on the corporate level, LLCs and partnerships too do NOT get taxed at the business level (unless you elect to pay taxes like a C Corp).

  1. Corporations that choose to be an S Corp
  2. LLCs
  3. Partnerships

Are “pass-through” entities, for tax purposes.

What EXACTLY is a Sole Proprietorship?

A Sole Proprietorship (sole trader or proprietor) is probably the simplest and most common structure. It’s weird to say this but,  there may even be people who don’t know they are  sole proprietors.

A Sole Proprietorship is an unincorporated business that has one owner who only pays personal income tax on his profits. Meaning, if you are a Sole Proprietor, then you did NOT legally register your business with state authorities. To this, there are both good parts and bad parts.

On one hand, you are entitled to all the profits your business makes. However, on the other hand,  you are responsible for debts, losses, and liabilities. On a legal level, there is no difference between you (your entity), the owner and your business (your business’s entity). You are considered ONE entity.  

Sole Proprietorship OR S Corp: The Perfect Choice

Characteristics of an S Corp: 8 PERFECT Elements Of An S Corp

S Corp Advantages: 4 COMPELLING Reasons Why S Corps Are GREAT

Advantage #1: Protected Assets

Probably the biggest advantage of an S Corporation is the fact that it protects your personal assets. The fact that it is created as a new entity tells us that your personal assets will be protected from business creditors.

Truth be told, all sorts of corporations and LLCs also shield your personal from any litigations or contracts.

Advantage #2: Pass-Through Tax

When you choose that your corporation should be taxed as an S Corporation, you are free from getting taxed 2x (“double-taxation”). This means that your corporation will not get taxed at the corporate level.

If you were to elect to have your corporation as a C Corporation, your business would get taxed at the corporate level as well (“double-taxed”).

Advantage #3: Easy To Transfer Ownership

Another advantage that S Corps have is that it is easy to transfer ownership of your corporation. Because your S Corp is an entity separate from you, personally, it can exist forever. Meaning, even after you, the owner, of the corporation has passed-away, the entity of the corporation can still exist. In order to transfer ownership of your S Corp, all you have to do is sell your to others.

Advantage #4: More Credibility / More Professionalism

Probably the MOST underrated advantage that an S Corp has is the credibility that comes with it. It is simply more professional to have a corporation.

When partners and customers will see that your business is an S Corp, they will want to invest their money in your business. They will believe that the product or service you are providing is more reliable.

S Corp Disadvantages: 4 GREAT Reasons Why S Corps SUCK

Disadvantage #1: More Expenses (fees)

Attaining an S Corp can be expensive. True, there are some advantages that come with it, but some states may require a minimum annual state tax. Also, the costs of filing the initial filing requirements may be costly, depending on the state. This is aside from the other costs you will have to start up your business.

Disadvantage #2: More Formalities

Being an S Corp means that you are a corporation. This means that you have legal formalities that you must follow. For example, you must hold annual shareholder meetings. I know this sounds crazy, but, this applies even if you are the ONLY shareholder.  You must have the specifics of this meeting written in the bylaws. Logging the minutes of this meeting is crucial in order to prove that the meeting took place.

Disadvantage #3: More Work To Set-Up

Think about it. A sole proprietorship does not have a single document that needs to be filed. All that needs to be done is getting to work. While when it comes to S Corps, the paperwork could be really tiring. Believe me, at times it feels like it doesn’t end.

You should weigh the time and effort that will be necessary when deciding to opt as a sole proprietor or as an S Corp. This can really be a problem for you if you are running on a budget.

Disadvantage #4: High IRS Scrutiny (the IRS can be down your backs)

When choosing to structure your business as an S Corp, all of your owners become employees of the corporation. The IRS requires that all of your employees get paid a reasonable salary. Meaning, the IRS wants you to pay yourself the same amount it would cost you to pay someone else for the same job. For this reason, the IRS scrutinizes S Corps much more. They check to make sure that you are actually paying yourself a reasonable salary. They don’t want no games, if you know what we mean.

If the IRS finds out that you are not paying your owners reasonably, they may deny your status as an S Corporation. Be sure to do research as to what is considered reasonable pay. We’ve gotta be honest here. When it comes to the IRS, you do NOT want play games. For us, this reason alone could be the determining factor when you have to choose – “S Corp VS Sole Proprietorship”. This kinda stuff is SCARY!

Characteristics Of A Sole Proprietorship

Sole Proprietor Advantages: 7 CRAZY Good Reasons Why You Should Be a Sole Proprietor

Advantage #1: Easy Set-Up

In every other case, in order to start working properly, you need to file paperwork. For example, the  Articles of Organizations must be filed in order to legally form your LLC. With a sole proprietor, however, there is nothing to file in order to become a sole proprietor. All you need to do is START WORKING!

Advantage #2: No Corporate Tax

Remember! In regards to taxation, your business can be a “pass-through” entity or it can be “double-taxed”. Here is the thing. If your business is NOT a separate entity from you, then it is impossible for you to be “double-taxed”. For this reason, your tax life as a sole proprietor is so much easier; you only get taxed once; it’s considered a “pass-through” entity.

Advantage #3: Easy Tax Set-Up

Unlike other business structures, you don’t need to file for an EIN. Your social security number will be enough just like any other other financial transaction. As a sole proprietor, however, there are some benefits if you choose to apply for and use an EIN.

Advantage #4: Easy Banking

From the biggest advantages of a sole proprietor, is the EASY banking. Being a sole proprietor means that you don’t need a separate business checking account in order to run your business.

Both making and receiving payments just became that much easier for you. You can use your personal checking account, which is in your own personal name.

Advantage #5: No Formalities

Other business entities must follow legal formalities. For example, a corporation must hold annual shareholder meetings.

Trust us, this type of “formality stuff” can be a pain-in-the-neck. This kind of stuff can lead to unnecessary stress. Potentially, this can create a BAD work environment in the work place.

As a sole proprietor there are no formalities that you need to follow. You can act as you wish. For us, this can be key factor to consider when you have to choose – “S Corp VS Sole Proprietorship”.

Advantage #6: Time Saver

Being a sole proprietor means that you don’t have to sign, file, register anything. This gives you the time and the energy to focus strictly on your business.

We are talking about a MASSIVE time-saver. Meaning, if you’re working on a deadline, then you’d better believe that this will work in your favor. As we mentioned before, the only thing stopping you from being a sole proprietor is WORKING!

Advantage #7: Low Fees And Costs

Many people, when starting their business, can be on a tight budget. If this is you, being a sole proprietor might help you out. There are no registration fees that you need to pay.

This can be crucial. Any other business entity has registration fees that can be very costly (depending on the state). Plus as a sole proprietor, you SAVE on the annual fee to maintain your registration.

Sole Proprietor Disadvantages: 3 Crucial Reasons Why You Should NOT Be A Sole Proprietor

Disadvantage #1: No Liability Protection (unlimited responsibility)

As a sole proprietor, you do NOT need to register your business. As a result of this, however, your business is NOT considered a separate entity.

Instead, your business is part of your own personal entity. This means, every business transaction that you made was done by you as an entity. If any liabilities, litigations, creditors are raised against you in court, you have no way to shield your personal assets.

Disadvantage #2: Less credibility / Less Professionalism

Another disadvantage of being a sole proprietor is that it is a lot harder to convince others that your business is reliable. Banks, investors, or customers may not feel comfortable to invest their money in you. If you didn’t INVEST the time to make YOUR OWN business official, then why should they INVEST in it?

Disadvantage #3: Harder To Sell Business

Because you are a sole proprietor, your business is part of your own personal identity. This means, the moment you die, so does your business. Being a sole proprietor makes it that much harder to pass your business on to someone else. For example, the buyer will not be able to keep the business name. This can bring the value of your business down.

Conclusion - S Corp VS Sole Proprietorship

Wow! now that was a lot.

But, with that said, we are confident that the 4.5 days we spent on this explains the balance of “S Corp VS Sole Proprietorship”.

You need to make the choice that’ll work BEST for you.