Differences Between a Sole Proprietorship and a Corporation

pexels anna shvets 5325104

Starting a company means making a lot of decisions and developing a solid business plan that will help you reach your long-term goals for success. One of the first choices you will make is deciding what entity structure is a good fit for your new venture. A sole proprietorship might be a good fit for those who prefer flexibility and total control over how they run their operations and finances. 

However, you might be considering the tax benefits of a corporation but aren’t sure how this formation differs from being a sole proprietor. These business structures have significant differences that can be advantageous depending on your industry.

What Is a Sole Proprietorship?

As one of the most flexible business formation options, it also comes with the most risk. To run a company as a sole proprietor, you can expect the following conditions to apply:

  • Only have a single owner
  • Pay all business taxes on your individual return as a pass-through entity
  • Be personally liable for any risks and debts your business incurs
  • Your personal assets are not separate from those of your company
  • Cannot sell stocks like a corporation
  • Have the ability to run your business as a DBA

When looking at the popularity of this structure compared to 19% of small businesses being corporations in 2018, sole proprietorships accounted for 12%. This shows significant favorability and a trend for smaller companies to scale up their formations later when further established. 

What Is a Corporation?

One of the primary features of a corporation (C-Corp) that differentiates it from sole proprietorships is the role of the business owner. Unlike being a sole owner where your business and personal assets are entwined, corporation owners are actually employees, and only the company can earn revenue. The business’s owner(s) are completely separate, meaning that the business itself can:

pexels mikhail nilov 8937612
  • Earn revenue
  • Be liable for taxes on those earnings
  • Is responsible for damages, losses, and harm caused to itself and others

As an owner-employee, you get paid a salary and pay taxes on that income like everyone else in your company. So it doesn’t matter if you are the only member of your corporation; you have to pay your share of payroll taxes like a typical employee.

Pros and Cons of a Sole Proprietorship Vs. a Corporation

You may think that sole proprietorships are the best option. However, C-Corps have significant benefits, depending on the needs of your business and the industry you’re in.

Top Article:  How to Start a Successful Real Estate Website

Consider the following benefits of operating as a sole proprietorship:

  • Complete business control
  • Formation requires no formal registration. Just obtain the business licensing required by your state and local governments.
  • Taxation treats your business income as personal income, so filing a return can be done individually. 

Sounds pretty impressive, right? Look at how corporations are quite advantageous:

  • No limit to the number of investors you have
  • Personal liability protection
  • Publicly trade your stocks and bonds
  • Unlimited number of investors

As you can read, your choice will hinge on which structure meets your business goals the best. For instance, you may like the fact a corporation shields your personal assets from business liabilities, but if you don’t plan to have stock options or need investors, is it worth it? 

With every upside, there is always a down. Consider the below cons of running a corporation or sole proprietorship may finalize your decision on which to choose.

Let’s start with some C-Corp drawbacks:

  • It costs more to operate
  • You will need to keep extensive records and provide legally-required reports
  • Setting up a corporation is more complex and costly
  • Income taxes have to be filed separately from your personal return
  • Corporations have more regulatory oversight demands

For sole proprietorships, the most significant risks include:

  • Your personal and business assets are subject to liability claims
  • Getting capital through bank loans or investors is more difficult to achieve
  • You can’t add additional owners to your structure 

Business Insurance Requirements for Sole Proprietors Vs. C-Corps

The perils your company faces and the level of commercial insurance needed to defend against these risks will depend on several factors, including:

  • Your industry
  • Business activities
  • Entity structure

Operating as a sole proprietor or C-Corp will always require a general liability policy at a minimum. In fact, some regulatory licensing and permits will demand you have this coverage, and you might not be able to contract with other businesses unless you’re insured. 

pexels rfstudio 3810753

Why is this coverage so important? If anything goes wrong, you’re personally liable as a sole proprietor. This means your private assets are up for grabs in a damages suit and those of your business. 

Corporations don’t face this issue, but they still need this policy. In situations where the losses or claims exceed what you own in company assets, you’ll still potentially have to liquidate those that are personal to cover the cost. However, a general liability policy rarely is all a business needs for adequate coverage, regardless of whether it is a corporation or sole proprietorship. 

Top Article:  9 Best Places to Buy Yelp Reviews in 2022 (Positive, 5 Star)

General risk coverage only applies to third-party claims, like a customer who fell on your premises or a driver injured in a car accident your employee caused. What if an employee gets hurt? Because they’re part of your company, workplace injuries have to be handled by Workers’ Compensation insurance; a required coverage in all but one state. 

You also have to consider what would happen to your business if operations got interrupted due to storm damage. How would you replace that revenue or replace ruined products and equipment? Or, if your employee at a hair salon accidentally burns a client’s scalp? You need professional liability in cases involving skilled service claims. 

At the end of the day, sole proprietors insurance coverage may be slightly more important since the owner has a larger burden of personal liability. Just remember that even as a C-Corp, you will still face much the same perils and risk nearly as much without proper insurance. 

Who Pays More Taxes: Sole Proprietorships or C-Corps?

The final factor to consider when choosing to operate your company as a corporation or sole proprietor is the tax situation you’ll face. Typically, you can expect to pay more taxes if you choose a C-Corp structure because your company is separate from you. This means it has to produce its own federal and state taxes on earned revenue. 

There are even instances where double-taxation occurs because your shareholders receive dividends which the IRS treats as income and then taxes again. 

As a sole proprietor, you are the business, so your income gets reported on your individual tax return. You’ll still have to pay your fair share of self-employment taxes, but you can set aside money throughout the year to be ready for that cost. 

Final Thoughts

Deciding whether you should be a sole proprietor or a corporation is an important decision with many implications that can affect your business. C-Corps are ideal if you already have a large company and want to protect your personal assets from liability. It’s also a beneficial structure for those wanting to keep business taxes separate from their private return. 

Sole proprietorships offer none of these benefits and allow you to retain total control of your company, though at a high price of total liability should something go wrong. Fortunately, you can create a comprehensive defense against the unexpected with a business owner’s policy with all the necessary features to protect your company and its team.

Leave a Reply