Choosing the right business structure for your company is one of the most important decisions you will make as an entrepreneur. Before you decide between establishing a sole proprietorship or a corporation, you should know the benefits of each and how they compare.
We are here to help with this guide to everything you need to know about sole proprietorships vs. corporations and which one is right for your business needs.
What Is a Sole Proprietorship?
A sole proprietorship is an informal business structure that is owned by a single individual. Since this business structure isn’t formally organized, it does not offer personal liability protection or tax benefits.
However, there are advantages to choosing a sole proprietorship rather than a formal business structure, such as not having to register your business with the state. Sole proprietorships are best suited for businesses that are low-profit and low-risk due to the lack of personal asset protection.
Keep in mind that if you choose to operate your sole proprietorship under an assumed name, you can register a “doing business as” (DBA) name to open a business bank account or receive payments under your fictitious name.
What Is a Corporation?
A corporation is a formal legal business structure that is owned by shareholders. While this is one of the more complicated business structures to form and maintain, there are some major benefits such as personal liability protection, tax benefits, and potential investor opportunities.
Businesses that expect to see high profits soon after they begin operations will get the most out of this business structure since it protects shareholder’s assets and makes finding outside investors easier than other structures.
What Is a C Corporation?
A C corporation (C corp) is the default structure of an incorporated company. C corps are a separate legal entity from the owners of the corporation with a basic organizational structure that includes shareholders, officers, directors, and employees.
What Is an S Corporation?
An S corporation (S corp) is an IRS tax designation, not a business structure. Businesses that choose to form either a corporation or an LLC can elect S corporation status to receive tax benefits in certain circumstances.
Not all businesses benefit from electing this tax designation, however. LLCs and corporations that meet the following factors could potentially receive tax benefits from this designation:
- Enough net profit to pay a “reasonable salary”
- At least $10,000 in distributions annually
- Payroll and accounting costs that don’t outweigh the tax advantages
- Meets IRS S corp requirements
Sole Proprietorship and Corporation Comparison
The biggest advantage of starting a corporation vs. sole proprietorship — by far — is the personal asset protection that shareholders have in the event the corporation is sued or owes a debt. With a sole proprietorship, the owner is completely responsible for any liabilities or debts of their business which can be an immense risk.
Moreover, corporations can claim self-employment tax savings among other tax benefits, while sole proprietorships offer no tax benefits as an informal business structure. In contrast, sole proprietorships save money with the low cost to establish this business structure, plus they aren’t liable for unemployment insurance.
Essentially, choosing to form a corporation vs. a sole proprietorship comes down to just a few things:
- Whether your business is small enough to act as an extension of yourself, allowing you to comfortably assume the financial responsibility of your business
- If your business can anticipate the level of growth that will benefit from tax savings, investment opportunity, and personal asset protection offered by a corporation.
Consider Forming an LLC Instead
If you’re still not convinced that establishing your business as a corporation or sole proprietorship is the right fit, consider forming an LLC instead.
LLCs are a formal legal business structure that offers the same personal liability protection as a corporation with its own tax benefits. Plus, starting and maintaining an LLC is far easier than a corporation and less risky than establishing as a sole proprietorship — it’s the best of both worlds!
You can also use an LLC formation service to register your LLC for you.
Sole Proprietorships vs. Corporations FAQ
Why is a corporation better than a sole proprietorship?
Forming a corporation offers many advantages compared to establishing a sole proprietorship, such as personal liability protection, tax benefits, and investor opportunities. In general, forming a corporation is a better choice for businesses that expect to make a substantial profit and want to protect the personal assets of its owners or shareholders.
However, a sole proprietorship could be the right choice for your business if it is a low-profit, low-risk venture. Furthermore, if you choose to restructure your business to become a corporation, the option is always available as your business grows.
What is the difference between a sole proprietorship and a corporation?
Sole proprietorships are an informal business structure that offers no tax benefits or personal liability protection but allows more flexibility and freedom for business owners.
Comparatively, corporations are formal legal business structures that offer personal liability protection, tax benefits, and investor opportunities but are complicated to maintain.
Which is better LLC or sole proprietorship?
LLCs or sole proprietorships can be the best choice for your business depending on your business’s needs. For example, sole proprietorships require no registration at the state level and allow for more flexibility since they aren’t formally organized, but they offer no personal liability protection, which means they aren’t ideal for many businesses.
Generally, we recommend forming an LLC rather than a sole proprietorship because, in addition to the protection of personal assets, LLCs offer tax benefits and are extremely easy to manage and maintain.