Before discussing specific business entities, let's clearly understand what constitutes a "business entity." A business entity is an organization created to engage in commercial activities. For those starting a solo business, these are the most common entity types:
- Sole proprietorship
- Limited Liability Company (LLC)
- Corporation
Sole proprietorship
If you begin operating your business without any formal setup, you're automatically a sole proprietorship. Key characteristics include:
- A single owner (you, from a legal and tax standpoint)
- Minimal or no formation costs
- Easy to manage
With a sole proprietorship, your personal and business finances are intertwined. This means your business profits are reported on your personal tax return. While straightforward, this can be a downside, especially if your business involves significant risks. Despite this, over 75% of solopreneurs initially choose this structure due to its simplicity.
Limited Liability Company (LLC)
An LLC offers a distinct advantage for business owners seeking to protect their personal assets from business debts and liabilities. An LLC:
- Creates a separate legal entity from its owner(s)
- Shields personal assets from business-related claims
- Can have multiple owners
Forming an LLC establishes a barrier between your personal and business finances. This level of protection is particularly valuable for businesses with potential risks or liabilities.
Determine which business entity is right for you
If you've decided on an LLC, you can file your taxes as a corporation. While your LLC remains the official business entity, a C-Corp or S-Corp designation can impact your business operations and tax obligations.
While you might associate corporations with attracting investors or offering stock options, these benefits may not be relevant to a solopreneur. However, other advantages should be considered.
A C-Corp allows you to file a separate business tax return, potentially reducing your income tax rate to 21%. This can benefit high-earning businesses as the rate doesn't increase with income. However, if you anticipate losses, especially during startup, C-Corp status may not allow you to deduct those losses from your personal income.
An S-Corp is a popular choice for solo businesses due to its potential to lower self-employment taxes. You're subject to the total 15.3% self-employment tax as a sole proprietor or LLC. With S-Corp status, you can pay half of that, leading to significant savings.
Regardless of your choice, corporations require more administrative tasks than sole proprietorships or LLCs. These include:
- Filing Articles of Incorporation
- Adopting bylaws
- Holding regular meetings (annual and organizational)
- Appointing directors, officers, and shareholders (even if you're the sole individual)
As a corporation, you'll pay yourself a salary and withhold Social Security and Medicare taxes, which you'll then remit to the IRS on behalf of your business. For more information on the benefits of using Lettuce as an automated S-Corp solution, visit What's the Difference Between an LLC and an S Corp? or sign up for the free webinar On-Demand Webinar: S Corp 101.
Explore the Lettuce demo to see how Lettuce can help you reach your freelance financial goals. Or sign up for the free Masterclass: How to Keep More of What You Earn to learn more about the benefits offered through Lettuce.
