Choosing Your Entity—Sole Proprietorship vs. LLC vs. S-Corp

by Craig on July 25, 2011

Clients often ask me the best entity choice when forming a new business venture. The answer is quite simple: “It depends.”

Like many decisions when it comes to taxation, your best course of action (what achieves your long run goals),  can’t be summed up in a blanket statement. Even beyond the scope of this article, there are other factors that may affect your situation, so always be sure to run your plans by your accountant and lawyer.

Without further ado, here are a few issues to consider with each form of business:

Sole Proprietorship—As a sole business person, without any formal action, your business will default to this form. Thus, this form of business involves the least hassle. However, a sole proprietorship leaves the business owner’s personal assets at risk. Should your business incur a liability beyond its own assets, you would be held personally liable.

Yes, that’s a big risk. For this reason, a sole proprietorship is often not the most advisable choice for a new business.

Limited Liability Company (LLC)—A limited liability company can be formed by simply filing paperwork with the state in which your company will be based. There is a fee ($500 in Illinois), but the additional upkeep required is minimal.

Unlike a sole proprietorship (or a general partnership), an LLC limits your personal liability in the unlikely event that your business incurs significant liabilities.

Additionally, an LLC allows your business much flexibility and is sometimes called the “chameleon” of business entities. Partnership agreements can be largely structured as you see fit, and should you change your mind, the entity can easily be switched to an S-corporation.

S-Corporation—Like an LLC, S-corporations also protect your personal liability. Even better, they can have significant tax advantages to a profitable business.

Of course, there is a catch (or two…) S-corps are subject to certain rigidities regarding their structure. Only individuals may be shareholders and there can only be one class of stock, meaning that if you own 10% of the company, you get 10% of the profits, no exceptions.

Furthermore, and potentially likely to affect even more business owners, corporations are subject to much more record keeping than are other forms of business. (AKA a hassle.) While it may be a pain, that’s the nature of taxation and law. Jump through the right hoops, and you will be rewarded.

That said, the above is a very general overview of entity selection. There are other less common but equally important factors that go into the decision as well. So, if you have any questions, feel free to leave a comment below or give us a shout!

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