Business Structure Guide

Sole Proprietorship

Best for: Freelancers, side hustlers, solo service providers earning under $60k profit/year.

A sole proprietorship is the default — if you start doing business and don't register anything, you're a sole proprietor. No registration, no state fees, no separate tax return. All income and expenses go on Schedule C attached to your personal 1040.

The big downside: unlimited liability. If a client sues you or you can't pay a supplier, they can come after your personal savings, house, and car. There is no legal separation between you and your business. For low-risk service businesses (writing, consulting, design), this might be acceptable. For any business with physical products, employees, or contracts, it's risky.

Tax example: If you earn $80,000 net profit as a sole proprietor, you pay $80,000 × 15.3% = $12,240 in self-employment tax (Social Security + Medicare) on top of income tax. That's $12,240 that an employee paying the same salary would split with their employer (only $6,120 out of pocket).

LLC (Limited Liability Company)

Best for: Most small businesses, real estate investors, freelancers earning $60k+ profit.

An LLC creates a legal wall between you and your business. Creditors can go after business assets but generally not your personal house or savings. Formation costs vary by state: $100 in Colorado, $300 in New York, $800 in California (annual franchise tax).

Tax treatment by default: A single-member LLC is a "disregarded entity" — same tax as a sole proprietorship (Schedule C). A multi-member LLC is taxed as a partnership (files Form 1065). The big advantage: you can elect S Corp taxation later without changing your business structure.

Real estate note: Many investors hold each rental property in a separate LLC to isolate liability. If one property gets sued, the others are protected. Some states (like Wyoming and Delaware) offer strong asset protection for LLCs, making them popular for holding companies.

S Corporation (S Corp)

Best for: Profitable businesses earning $80-100k+ profit/year where the owner wants to minimize self-employment tax.

An S Corp is a tax election (filed via Form 2553), not a business structure. You form an LLC or C Corp first, then elect S Corp status. The key benefit: only your salary (not total profit) is subject to self-employment tax. The remaining profit passes through without SE tax.

Tax example: A business earns $150,000 profit. As an LLC, you pay 15.3% SE tax on the full $150,000 = $22,950. As an S Corp with a $75,000 "reasonable salary", you pay 15.3% on $75,000 = $11,475 — saving $11,475 in SE tax. The savings more than justify the additional payroll costs ($500-1,500/year for a payroll service).

Caveat: The IRS actively audits S Corps that pay unreasonably low salaries. If you show $150k profit and pay yourself $20k salary, you will be audited and owe back taxes plus penalties. A reasonable salary is typically 30-60% of total profit, depending on your industry.

C Corporation (C Corp)

Best for: Startups planning to raise venture capital, businesses with 10+ employees, or companies planning to go public.

A C Corp is a completely separate tax entity. The corporation pays 21% federal tax on its profits. When those profits are distributed to shareholders as dividends, they're taxed again at the shareholder level — this is "double taxation." For most small businesses, this makes C Corps less tax-efficient than pass-through entities.

Why choose a C Corp anyway? Venture capital funds require C Corps because of specific tax rules (QSBS under Section 1202 allows up to $10 million of capital gains to be excluded when selling C Corp stock held for 5+ years). C Corps can also offer employee stock options in a tax-advantaged way. Delaware C Corps are the standard for startups because Delaware has a well-established business court system and predictable corporate law.

Comparison Table

How to Choose — Decision Guide

• Less than $60k profit, low risk: Sole proprietorship. No cost, no paperwork. Upgrade to an LLC once your income justifies the $100-800 annual cost.
• $60k+ profit, liability concerns: LLC. The liability protection alone justifies the annual fee. In high-risk businesses (contracting, manufacturing, health services), never operate as a sole proprietor.
• $100k+ profit, want SE tax savings: LLC taxed as S Corp. At $100k profit, the SE tax savings (~$3,500) more than covers the payroll service cost ($500-1,000). Hire a CPA for the initial election.
• Raising VC funding: C Corp incorporated in Delaware. VCs require C Corps. Plan for the double taxation — the trade-off is access to growth capital.
• Real estate investing: Separate LLC per property to isolate liability. Some investors use a series LLC (available in Delaware, Nevada, Texas) for cost efficiency.
• Side business while employed: Start as a sole proprietorship. You can always convert to an LLC later without tax consequences in most states.

Common Mistakes

• Forming an LLC in a state you don't operate in: "Delaware LLC" is popular but costs extra if you operate elsewhere — you pay Delaware franchise tax AND your home state registration fees.
• Not getting an EIN: Even sole proprietors need an EIN to open business bank accounts and file some tax forms.
• Mixing personal and business finances: The #1 way to lose your LLC's liability protection (piercing the corporate veil). Always maintain separate bank accounts.
• Electing S Corp too early: If your profit is under $60k, the payroll costs of an S Corp exceed the SE tax savings. Wait until the math works.