At Harvard Business Services, Inc., we know that when you start your own business, it can be confusing to know which corporate structure is best for you and your business. The article "The Skinny on Sole Proprietorship" from Entrepreneur.com does a fantastic job of clarifying some of the confusion regarding a Sole Proprietorship and the benefits of the S-Corporation. Below is an excerpt:
Though there are tax benefits to being a sole proprietor (no employees = no payroll tax--huzzah!), you are personally liable if a legal situation arises. This is especially important for those providing services like construction and financial consulting.
"If you are dealing with individuals' money that is typically invested in the stock market, this tends to be a very sensitive [and potentially litigious] issue," says Robert Fuest, principal of LandorFuest Capital Management. "You must understand all of your risks."
Those risks go beyond just upsetting a client. For instance, a default on a debt or other payment can result in a creditor legally coming after your personal property and assets or other possessions.
Fuest advises new business owners to look at their entire financial situation and take into account any plans to grow and include partners and employees. "The LLC offers more flexibility when it comes to operating and more personal protection," says Fuest.
Once your sole proprietorship is up and running, Fischer recommends treating your business like a business, something that those who freelance from a home office would do well to remember. "Be professional at all times and make time for things like marketing and networking."
This includes everything from having professional-looking materials (business cards, letterhead, invoices, etc.), to answering the phone properly and dressing appropriately. Deshayes says this can go a long way toward impressing clients and making them comfortable giving you work.
When purchasing these materials, Deshayes says it's important to keep personal money and business funds separate. "Keep your books clean and avoid comingling funds, which could open you up to legal liability."
Though there is no mandatory income threshold, Estill uses a guideline of around $50,000 per year gross as a starting point to consider converting a sole proprietorship to an S corporation (assuming they are not at risk for liabilities--then, forming an LLC would make more sense).
Estill says the primary tax benefit of an S corporation is that the owner controls the payment of employment taxes (via a declaration of salaries or wages). In a sole proprietorship, all net profits are taxed at the self-employment rate, which is currently 15.3 percent on the first $106,800 of net business income.
That rate remains the same for either structure, but the business owner can save some money with the S corporation. They may draw a salary (let's say half of what they'd declare as net income on a sole proprietorship) and pay the 15.3 percent on that. "The rest of the income flows to your personal tax return on a Schedule K-1, which ends up being subject only to income taxes," observes Deshayes.
There are costs associated with setting up an S corporation, including filing fees and corporate taxes, but Estill says, "The S corporation can be set up in any of the 50 states with only one shareholder, so it is an ideal business entity for a single-person venture."
Fuest advises looking before you leap, no matter what the structure. "The laws always change, and depending on the size of the business, you could be at an advantage one year and a disadvantage the next. It really comes down to your personal plans for growth."