Wondering whether a sole proprietorship or corporation is a better business structure for your company? These business types differ sharply when it comes to formation, taxation, and personal liability. When choosing between them, there’s no right or wrong answer; your selection should depend on your business model and goals.
Key Points
• Sole proprietorships are easy to set up, with minimal paperwork and straightforward tax rules.
• Corporations offer full personal liability protection, safeguarding owners’ personal assets.
• Corporations have better access to financing options, including selling stock and securing loans.
• C corps, S corps, and B corps have different features and tax implications, catering to distinct needs.
• The choice between a sole proprietorship and a corporation depends on your business goals, risk tolerance, and growth plans.
Understanding Sole Proprietorships
When you’re researching whether to form a sole proprietorship versus corporation, you’ll find that the sole proprietorship model is easier to set up and operate. There is no formal paperwork needed besides licenses or permits based on your business type and local laws. That may be why it’s the most common business structure in the U.S.
A sole proprietorship is a popular option for consultants, freelancers, home care assistants, professional cleaners, and landscapers — or any other business with just one person providing the product or service.
A sole proprietor owns and runs an unincorporated business alone. Any business income passes through to you as personal income, meaning you need to file only your 1040 tax return plus a Schedule C form.
Advantages and Disadvantages
As you can imagine, there are both pros and cons to sole proprietorship. Here are some examples:
Pros
• Sole ownership: A sole proprietor has complete ownership of the company, with full control of all business and financial decisions.
• Streamlined taxation: With a sole proprietorship, business income is considered personal income, so you only have to file one tax return.
• Easy setup: Forming a sole proprietorship requires minimal paperwork; you achieve this status automatically just by conducting business activities.
Cons
• Personal liability: As a sole proprietor, you’re personally liable for business-related debts and other responsibilities. That puts your personal assets at risk in case of loan defaults or lawsuits.
• Financing challenges: If you want to grow your business with external funding, you may have a harder time with a sole proprietorship. For example, you can’t raise funds by selling company stock. Also, according to the Small Business Administration (SBA), many banks won’t lend money to sole proprietorships. That may be the case even for secured loans like equipment loans.
• No tax benefits: When looking into the tax benefits of a sole proprietorship vs. corporation, you may find that a corporate structure allows you to take more deductions.
Taxation for Sole Proprietorships
Sole proprietorships do have tax issues to consider. A sole proprietorship is a “pass-through” entity. This means all of the business proceeds pass through the company to the owner as personal income, which must be reported on your personal tax return.
Sole proprietors earning more than $400 must also pay self-employment tax, which takes the place of Social Security and Medicare contributions that an employer would typically cover. The self-employment tax rate is 15.3%. For earnings above $168,600 (in 2024), the tax is reduced, depending on your income.
The final tax consideration for sole proprietorships is the need to pay quarterly estimated taxes. This is typically required if you expect to owe more than $1,000 for the tax year. Underpaying your estimated tax through the year can result in a penalty.
Recommended: Sole Proprietorship vs. LLC: How to Choose
Understanding Corporations
Forming a corporation creates a separate legal entity that shields your individual finances. Incorporating your business takes more upfront work, but there are some advantages, especially if you plan to apply for small business loans to grow your company over time. Here’s an overview of the different types of corporations you can choose from.
Types of Corporations (C, S, and B)
You can choose from three types of corporations. Each has slightly different features to consider.
• C corp: This is a basic corporation, a separate legal entity from its owner or owners. You must file articles of incorporation in the state where the company does business. You’ll need to have a registered agent, a set of bylaws, and regular board meetings.
• S corp: An S corp is a type of corporation that involves some extra legwork but yields certain benefits. Like a C corp, it shields the business owner from personal liability. Like a sole proprietorship, it avoids double taxation; profits and losses are passed through to the owners without being subject to corporate taxes. This is similar to an LLC’s tax benefits. But the IRS’s rules for S corp status do limit the company’s number of shareholders and stock classes.
• B corp: A B corp is a benefits corporation that balances its financial profits with the mission of providing some kind of public benefit. The business’s taxation profile is that of a C corp. However, this status is not available in all states.
Advantages and Disadvantages
Here’s what to consider when weighing the pros and cons of a corporation over a sole proprietorship.
Pros
• No personal liability: A corporation is its own separate legal entity; this keeps the owners’ personal assets safe from any kind of liability related to the business.
• Easier business financing: You can sell company stock to investors and improve your odds of corporate financing through a loan or business line of credit.
• Company longevity: A corporation can continue to exist after your departure or death, unlike a sole proprietorship.
Cons
• Formation is more expensive: States typically charge higher fees for registering a corporation than for other types of business entities.
• Recordkeeping requirements: Recordkeeping rules vary by state, but often you must submit annual reports and maintain records of shareholder and director meetings.
• Taxation varies: Income from C corps and B corps generally faces double taxation, once at the corporate level and once on owners’ personal tax returns. Setting up your business as an S corp frees you from paying corporate tax on your earnings.
Taxation for Corporations
A corporation must file its own tax return, separate from the individual owners, using IRS Form 1120. This brings together the business financials — including income, credits, and deductions — to determine the company’s tax bill. The flat tax rate for corporations is 21%.
Employment taxes are also required. You’ll file quarterly forms recording the income, Social Security, and Medicare taxes you’re paying on behalf of your employees.
Finally, business owners may owe income tax on any earnings or distributions taken from the company. Calculating the tax depends on whether you’ve elected S corp status through the IRS.
Recommended: Startup business loans
Side-by-Side Comparison
See the pluses and minuses of a sole proprietorship versus corporation, based on both short-term and long-term business considerations.
Formation, Liability, Taxes, and Growth Potential
| Entity Type | Formation | Liability | Taxes | Growth Potential |
|---|---|---|---|---|
| Sole Proprietorship | Minimal paperwork | No personal liability protection | Income tax
Self-employment tax |
Harder to obtain investments or financing |
| Corporation | More complex paperwork that varies by state | Offers full personal liability protection | Corporate tax
Employment tax Income tax for owners |
Easier to qualify for investments and financing |
Choosing the Right Structure for Your Business
Choosing between a proprietorship vs. corporation depends on factors like how risky your business is and how you plan to grow in the future.
When to Choose Each Option
A sole proprietorship is better for lower-risk companies. If the chance of a lawsuit is minimal — such as with a tutoring service or drop-shipping business — it’s less likely that your personal assets will be at risk. Additionally, as the only owner of a sole proprietorship, you can make all the decisions.
Setting up a corporation may be wiser if you want support from multiple owners. If lawsuits are a possibility, this status will protect your personal assets by keeping them separate from the business. Incorporating your business may also be a better choice if you foresee raising capital through investors or getting financing from a lender in the future.
The Takeaway
Deciding what governance structure to adopt is a strategic business move. When making the choice, consider your long-term plan for your business. If you expect to need investor capital, lender financing, and employees, incorporating may be the way to go. If you expect to keep running a solo shop and prefer straightforward tax rules, a sole proprietorship may be right for you.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What are the main differences between a sole proprietorship and a corporation?
There are several differences when choosing between a sole proprietorship or corporation. A sole proprietorship is easier to set up but doesn’t protect you from personal liability. A corporation does separate business and personal liability, but is more complicated to set up and forces compliance with recordkeeping rules.
Which business structure offers better liability protection?
A corporation offers better liability protection because the individual and the business are two separate legal entities. In case of liability or bankruptcy, only the assets of the business are paid out or sold. The assets of the corporate shareholders are protected. This is not the case with a sole proprietorship.
How do taxes differ between a sole proprietorship and a corporation?
With a sole proprietorship, all business income flows through to the owner and is treated as personal income. By contrast, a C corporation must pay taxes on its income before being paid out to the shareholders.
Is it easier to start a sole proprietorship or a corporation?
A sole proprietorship is easier to start because there is minimal paperwork required.
Can a sole proprietorship be converted into a corporation?
Yes, you can convert a sole proprietorship to a corporation by forming a new entity and transferring any business assets to the new corporation.
Photo credit: iStock/Caiaimage/Paul Bradbury
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