What choice of entities do I have for my small business?

In our practice, the entities most commonly used for small businesses (other than rental activities) are sole proprietorship and S-Corporation. An LLC is another popular form of entity. A sole member LLC can elect to be taxed either as a sole proprietorship or a corporation, including an S-corporation. An LLC with more than one member can also elect to be taxed as a partnership. This discussion does not address partnerships or regular corporations only because they are less commonly used for small businesses.

Regardless of entity choice, generally any trade or business, other than a regular corporation, is eligible for the Qualified Business Income Deduction, including sole proprietors.

This is only intended as an overview and may not address all of your specific circumstances. Please contact us for assistance in deciding what is best for your business.

A sole proprietorship is an entity in its simplest form. It only has one owner and all of the activity is reported on the owner’s Form 1040 on Schedule C. A sole proprietorship is not a separate legal entity from its owner. They are one in the same.

Advantages of a sole proprietorship

  • State requirements are simpler assuming you haven’t formed an LLC.
  • No payroll for the owner so no need to learn and prepare payroll unless you have employees.
  • Retirement plan contributions can be based on the total net income of the company.
  • Accounting records can be simpler – no need to keep a balance sheet although it is still advisable.
  • Only one tax return to file. All activity goes on Schedule C of Form 1040.

Disadvantages of a sole proprietorship

  • All net income of the business is subject to self employment tax (social security/medicare).
  • Must make equal quarterly estimated tax payments to cover income tax and self employment tax to avoid or minimize underpayment tax penalties.
  • Less legal protection for its owner since a sole proprietor is not a separate entity. (please consult your attorney)
  • Can only have one owner.
An S-corporation is a corporation that qualifies for and has elected to be taxed as an S-corporation for income tax purposes. Since a corporation is a legal entity separate from its owner, you must first form a corporation with your state and then make an S-Corporation election. S-corporations are “pass through” entities meaning that tax is not paid at the corporate level but rather taxable income is passed through to the shareholders and income tax on the corporation’s income is determined at the individual level.

Advantages of an S corporation

  • Potential liability protection because the corporation is a separate legal entity (please consult your attorney).
  • Potential savings on social security and Medicare taxes since only the amount taken as wages is subject to those taxes.
  • Estimated taxes can be paid through withholding on wages taken from company. This provides a planning opportunity to help avoid underpayment tax penalties.

Disadvantages of an S corporation

  • Must incur one-time expense to form a corporation, possibly with the help of an attorney.
  • Likely to need more CPA help – two tax returns to file each year, help with payroll, other issues unique to S corporations etc.
  • More record keeping – must have clean accounting records.
  • Keep up with state legal requirements for corporations – board meeting minutes, annual reports etc.
  • Must take “reasonable” compensation from corporation in form of wages.
  • Retirement plan contributions can be calculated on wages only.