When you first start a business, you don’t have to give too much thought to your legal structure, especially if you’re the boss and the only employee. For a team of one, being a Sole Proprietor makes sense. Still, at some point, you may want to change your sole proprietorship to a corporation or limited liability company (LLC). Soon, you’ll have questions like:
- “Should I incorporate? If so, when?”
- “Should I choose a corporation or an LLC?”
- “Which business entity is best for my company?”
To help you decide whether you should incorporate or become an LLC, it’s important that you understand the advantages to both your current sole proprietorship as well as a corporate or LLC structure. Take a look.
What’s Great About Being a Sole Proprietor
A sole proprietorship essentially means that you and your business are one and the same entity. This is often the route freelancers take because it requires no legal forms. Here are some advantages to a sole proprietorship:
1. Simpler taxes
As a sole proprietor, you don’t have to file separate business taxes. However, you should still keep track of all of your business expenses and income as you’ll need to file this on a Schedule C along with your personal tax return. You can also use any business losses to offset other income on your tax return. For example, if you’re starting your business while still employed elsewhere, your business losses can help reduce the annual taxes you may need to pay.
2. Less paperwork
A sole proprietorship doesn’t require preparing separate financial statements for your business and other types of reports necessary for corporations.
3. You can keep all your profits
As the sole owner, you are entirely responsible for your business – the good and the bad. You’re the only one who will keep things afloat and running smoothly. You’re also the one who gets to keep your business profits.
Advantages to a Corporation or an LLC
Incorporating your company or forming a limited liability company makes your business a separate entity. There are different types of corporate entities for small businesses, including an S Corporation (also called S-Corp) and an LLC.
An S-Corp is a common structure among small businesses because individual owners pay taxes on their company’s earnings without paying separate business taxes on the entity’s net income, according to LegalZoom. An S-Corp is considered a good option for businesses that plan to grow by taking on outside investors or going public.
An LLC, however, is perhaps the most popular structure for small businesses as it has fewer legal requirements and many of the same benefits as an S-Corp. Let’s take a look at some of the advantages to these structures:
1. Your assets are protected
This is a big one. With an S-Corp or LLC, your personal assets are shielded from lawsuits and bankruptcies. For example, if someone slips and falls in your office and you’re a sole proprietor, you can be sued as your personal and business assets are rolled together. If your business is a corporation or LLC, however, a lawsuit would be filed against your business, so your personal assets aren’t on the line. Likewise, if you’re in a car accident and sued, no one can come after your business assets to settle a personal claim against you.
Some consumers and vendors prefer to do business with a corporation or LLC rather than an individual. For example, having an “Inc.” or “LLC” after your company name can lend an air of legitimacy to your small business.
If you’re a sole proprietor and close your business or pass away, the company goes away too. If your business is a corporation or LLC, it can continue operating in your absence. If you plan to pass the business along to your children or a partner, an LLC or S-Corp may be the way to go.
Although a sole proprietorship is the easiest structure because no documents are necessary, you leave yourself open to possible lawsuits and other financial liabilities. For this reason alone, it’s a wise idea to structure your business as an S-Corp or LLC, says Ian Engstrand, a partner at Goodwin Procter LLP in Boston.
“Both of these entities shield you from liability and they are both tax-efficient. Why not take advantage of this?” he says.
Engstrand recommends filing necessary corporation certificates or LLC formation documents yourself for free via any number of online sites, including Goodwin Procter’s Founders Workbench. The site shows you how to complete and file forms step by step.
“We’d rather business founders do it this way than dig into their pockets. This way, they can spend their money on other legal services down the line.”
To learn more about whether an S-Corp or LLC is the right structure for your business, it’s a good idea to consult with an attorney or tax advisor, says Engstrand.