Difference between Sole Proprietorship and an S Corporation

Introduction

A sole proprietorship and an S corporation are two different types of business structures. While both provide protection from personal liability, they have fundamental differences that make one a better option for some entrepreneurs than the other.

Sole Proprietorship

A sole proprietorship is a business owned by a single person. It does not have any legal structure and does not pay taxes as a corporation, but as an individual.

S Corporation

An S corporation is a type of corporation that enjoys pass-through taxation. In other words, the responsibility for paying taxes on its income passes through to its shareholders. This means that the corporation doesn't pay any corporate taxes on profits made by the company; instead, it distributes them to shareholders who report their share as personal taxable income on their tax returns. The only time a shareholder will be taxed at both the corporate and personal levels is if he has distributed his shares in the company or if he sells his stock for a profit (in which case he pays capital gains tax).

Formation

A sole proprietorship is formed by filing a DBA (doing business as) certificate with the state. You are responsible for paying all taxes and reporting your profits on your personal income tax return. A corporation is formed by filing articles of incorporation with the state. The corporation then issues shares to its shareholders, who report their share as taxable income on their tax returns. Corporation taxes are paid by the company and not directly deducted from your paycheck.

Ownership

In a sole proprietorship, ownership is vested in one person. In an S corporation, the ownership is separated into shares. Shares may be owned by one or more individuals.

Liability Protection

As a sole proprietor, you are personally liable for all debts and other obligations of the business. This means that if you run into financial troubles, creditors can come after your personal property (like your house) to pay off any debts they have with your business. On the other hand, an S corporation has limited liability protection. In this case, shareholders are not held personally liable for the company's debts or obligations—the corporation itself is responsible for them instead.

Taxation

In a sole proprietorship, the business is taxed as a sole proprietorship. This means you report your company’s income or losses on your personal tax return and pay taxes on it as if it were just another source of income like a job or investment. Sole proprietorships are also not subjected to double taxation, which means that when you earn money with your business and then spend it on something else (like buying new equipment), there isn’t any additional tax for having accumulated those funds in the first place. Corporations are taxed separately from their owners, which means they pay taxes on their profits as separate entities. This separation is intended to prevent individuals from using the corporation as a means of personal tax evasion (although it can still happen).

Takeaway

The way that you choose to set up your business will have an effect on the amount of taxes you will pay. If money is an issue, a sole proprietorship might be the best choice. However, if you are looking for more protection or want to limit the liability of your business obligations, then a corporation may be better suited to your needs.

Conclusion

The decision to set up your business as a corporation or sole proprietorship can have a large impact on the amount of taxes you will pay. If you are looking for more protection or want to limit the liability of your business obligations, then a corporation may be a better choice. However, if money is an issue, then a sole proprietorship might be best suited to your needs.