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S Corp vs. Sole Proprietorship: Key Differences

Meow Technologies, Inc.

Meow Technologies, Inc.

Choosing the right business structure is one of the most important decisions an entrepreneur makes when starting a business. The business structure impacts everything from day-to-day operations, to taxes, to personal liability. When it comes to one-owner businesses, two of the most common structures are sole proprietorships and S corporations. Both have their advantages and disadvantages depending on the business's goals.

Defining Sole Proprietorships

A sole proprietorship is the simplest business structure. It is an unincorporated business owned and run by one individual. All that is required to form a sole proprietorship is obtaining the required licenses and permits. The business itself does not exist as a separate legal entity, meaning there is no legal separation between the business and the owner. The owner has complete control of the business, but also faces unlimited personal liability for its debts and obligations.

Pros:

  • Easy and inexpensive to form
  • Complete owner control
  • Business income and losses are reported on the owner's personal tax return

Cons:

  • No liability protection
  • Difficulty raising investment capital
  • Subject to self-employment tax on all income

Sole proprietorships can be a good choice for low-risk businesses, especially when first testing out an idea. But the lack of liability protection puts personal assets at risk.

Defining S Corporations

An S corporation is a legal entity formed by filing articles of incorporation with the state and electing S corporation status with the IRS. It gets legal protections of incorporation while being taxed similarly to a partnership or sole proprietorship. Income and losses pass through to owners’ personal tax returns.

S corporations have up to 100 shareholders. All shareholders must be U.S. citizens or resident aliens, and other corporations or partnerships cannot be shareholders.

Pros:

  • Liability protection for owners
  • Access to capital through sale of stock
  • Avoidance of self-employment taxes on distributions
  • Income taxed only once on owners' personal returns

Cons:

  • More complex formation process
  • Stricter reporting requirements
  • Doesn't allow all business types
  • Must follow corporate formalities

S corps allow business owners to shield personal assets from liability while avoiding double taxation. This makes them an appealing choice, especially for higher-risk businesses.

Key Differences

Liability Protection

Sole proprietors have unlimited personal liability. This means creditors can seize personal assets to settle business debts. S corporation shareholders have limited liability protection similar to that of C corporations.

Raising Capital

Sole proprietors can only raise funds through debt financing, making it more difficult to fund expansion. S corporations can raise capital by issuing stock.

Taxes

Sole proprietor business income is subject to self-employment tax (15.3%) as well as personal income tax. Only reasonable salaries paid to S corporation shareholder-employees are hit with self-employment tax. The remaining pass-through income is only taxed once (no corporate level taxes).

Reporting Requirements

Sole proprietors only need to file a personal tax return. S corporations must file articles of incorporation, hold director and shareholder meetings, keep corporate minutes, and file corporate returns in addition to owners’ personal tax returns.

Eligible Businesses

Any type of business can be a sole proprietorship. S corporations cannot be used by financial institutions, insurance companies, or large firms. Some states also limit S corporation eligibility.

When to Switch from Sole Proprietorship to S Corp

There is no definitive threshold dictating when a business should switch from a sole proprietorship to and S corporation. Some key triggers include:

Business Risk Profile

If business activities frequently expose your personal assets to liability claims, an S corporation helps shield your personal assets. The protection is especially valuable for higher-risk industries like construction or healthcare.

Seeking Outside Investment

Sole proprietors can only use debt to fund growth. Equity financing options like selling shares of stock allow S corporations to raise larger amounts of capital.

Tax Savings

Weigh the added tax preparation costs and reporting requirements against the potential self-employment tax savings from distributions (rather than salary) to see if an S corporation is worthwhile for your business.

Every business situation is different. Speaking with accounting and legal experts can provide the personalized guidance needed to determine if transitioning to an S corporation makes sense.

Conclusion

Sole proprietorships and S corporations each have advantages and disadvantages for small business owners to consider when structuring their company. Sole proprietorships offer administrative ease, but expose owners’ personal assets to substantial risk. S corporations provide liability insulation and access to equity capital markets, but come with legal formalities and front-end costs. As companies evolve, structural choices should be revisited to ensure business needs are fully addressed in the most beneficial manner possible. With the input of trusted advisors, entrepreneurs can confidently put the right foundational elements in place to set their endeavors up for lasting success.

Meow Technologies is a financial technology company, not a bank or FDIC-depository insured institution. Likewise, Meow Technologies is not an investment adviser and none of the information presented herein should be relied upon as financial advice or a recommendation to make any financial decision nor should it be considered to be tax or legal advice. The information is the opinion of Meow Technologies for educational purposes and may not be suitable for all companies. Products, like the one described herein, are offered through Meow Technologies and are not advisory services which are only offered through Meow Advisory, LLC.** The FDIC’s deposit insurance coverage only protects against the failure of an FDIC-insured bank.**

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*Disclaimer: Meow Advisory LLC is a registered investment adviser. Registration as an investment adviser does not imply any level of skill or training.
For accounts opened through Atomic Brokerage LLC: Meow Advisory LLC has an engagement with Atomic Brokerage LLC (“Atomic Brokerage”), a registered broker-dealer and member of FINRA and SIPC , to bring you the opportunity to open a brokerage account. Brokerage services for customers of Meow Advisory LLC are provided by Atomic Brokerage. For more details about Atomic Brokerage, please see the Form CRS, General Disclosures, and the Privacy Policy. Check the background of Atomic Brokerage on FINRA’s BrokerCheck.
For subadvisory services for accounts opened through Atomic Invest LLC: Meow Advisory LLC has an engagement with Atomic Invest, LLC (“Atomic Invest”), an SEC-registered investment adviser, to bring you the opportunity to open an investment advisory account. Investment advisory services are provided by Atomic Invest. Companies which are engaged by Atomic Invest receive compensation of 0% to 0.85% annualized, payable monthly, based upon assets under management for each referred client who establishes an account with Atomic Invest (i.e., exact payment will differ). Atomic Invest also shares a percentage of compensation received from margin interest and free cash interest earned by customers with Meow Advisory LLC. Meow Advisory LLC is not a client of Atomic Invest, but our engagement with Atomic invest gives us an incentive to refer you to Atomic Invest instead of another investment adviser. This conflict of interest affects our ability to provide you with unbiased, objective information about the services of Atomic Invest. This could mean that the services of another investment adviser with whom we are not engaged could be more appropriate for you than Atomic invest. Advisory services through Atomic Invest are designed to assist clients in achieving a favorable outcome in their investment portfolio. They are not intended to provide tax advice or financial planning with respect to every aspect of a client’s financial situation and do not include investments that clients may hold outside of Atomic Invest. For more details about Atomic Invest, please see the Form CRS, Form ADV Part 2A, the Privacy Policy, and other disclosures. Brokerage services for Atomic Invest are provided by Pershing Advisor Solutions LLC (“PAS”), a registered broker-dealer and member of FINRA and SIPC.
Neither Atomic Invest nor Atomic Brokerage, nor any of their affiliates, is a bank. Investments in securities are Not FDIC insured, Not Bank Guaranteed, and May Lose Value. Investing involves risk, including the possible loss of principal. Before investing, consider your investment objectives and the fees and expenses charged by Atomic Brokerage and/or Atomic Invest.
See the Legal Section within the Meow website for additional agreements.

U.K. Gilt pricing quoted net of fees. ~5% U.K. Gilt yield is sourced from Investing.com December 2023 6-month United Kingdom 6-Month Bond Yield. ~5% Treasury Bill yield is sourced from treasurydirect.gov December 2023 12-week U.S. Treasury Bill auction.

**Disclaimer: Meow Technologies is a financial technology company, not a depository, bank or credit union, and your account at Meow is not, itself, an FDIC-insured product.

Meow currently partners with three banking providers. Banking services are provided by Third Coast Bank SSB; Member FDIC, Grasshopper Bank, N.A; Member FDIC, and FirstBank, a Tennessee corporation; Member FDIC.

By opening a Maximum Checking account through Meow and if you choose to receive banking services provided by Grasshopper Bank, N.A, you deposit your funds into a deposit account at Grasshopper Bank, N.A. which sweeps those funds into deposit accounts across a network of Federal Deposit Insurance Corporation (“FDIC”)-insured banks, for up to the current standard maximum deposit insurance amount (“SMDIA”) of $250,000 per eligible depositor, per destination institution, for each ownership capacity or category, subject to applicable terms and conditions, including Grasshopper's ICS Deposit Placement Agreement. Grasshopper Bank, N.A. uses a third-party vendor and agent to help administer this sweep process. Visit https://www.intrafi.com/network-banks/ for a list of the banks and savings associations with which we/Grasshopper, N.A. have a business relationship for the placement of deposits at destination institutions, and into which your deposits may be placed (subject to applicable terms with you, and any opt-outs by Grasshopper, N.A. or you). The current maximum deposit insurance amount for your funds is up to $125 million in FDIC insurance through the sweep network of Grasshopper Bank, N.A, subject to change at any time with notice from Meow and/or pursuant to applicable law. Terms and restrictions apply. Subject to applicable rate sheet. Interest rate on checking products quoted in Annual Percentage Yield (APY). Interest rates and yields are effective as per the date on the applicable rate sheet. See applicable terms and restrictions and refer to the applicable rate sheets for additional information.

By opening a Maximum Checking account through Meow and if you choose to receive banking services provided by Third Coast Bank SSB, you deposit your funds into a deposit account at Third Coast Bank SSB. If you also hold funds in a sweep program with Third Coast Bank SSB, Third Coast Bank SSB sweeps those funds into deposit accounts across a network of FDIC-insured banks, for up to the current SMDIA of $250,000 per eligible depositor, per receiving bank, for each ownership capacity or category, including any other balances you may hold at that receiving bank directly or indirectly through other intermediaries, including broker-dealers. Third Coast Bank SSB uses a third-party vendor and agent to help administer this sweep process. Visit Third Coast Bank SSB for a list of the banks and savings associations with which we/Third Coast Bank SSB have a business relationship for the placement of deposits at receiving banks, and into which your deposits may be placed (subject to applicable terms with you, and any opt-outs by Third Coast Bank or you). The current maximum deposit insurance amount for your funds is up to $50 Million in FDIC insurance through the sweep network of Third Coast Bank, subject to change at any time with notice from Meow and/or pursuant to applicable law. Terms and restrictions apply. Subject to applicable rate sheet. Interest rate on checking products quoted in Annual Percentage Yield (APY). Interest rates and yields are effective as per the date on the applicable rate sheet. See applicable terms and conditions and refer to the applicable rate sheet for additional information.

By opening a Maximum Checking account through Meow and if you choose to receive banking services provided by FirstBank, a Tennessee corporation, you deposit your funds into a deposit account at FirstBank, which sweeps those funds into deposit accounts across a network of FDIC-insured banks, for up to the current SMDIA of $250,000 per eligible depositor, per destination institution, for each ownership capacity or category, subject to applicable terms and conditions, including FirstBank's ICS Deposit Placement Agreement. FirstBank uses a third-party vendor and agent to help administer this sweep process. Visit IntraFi for a list of the banks and savings associations with which FirstBank has a business relationship for the placement of deposits at destination institutions, and into which your deposits may be placed (subject to applicable terms with you, and any opt-outs by FirstBank or you). The current maximum deposit insurance amount for your funds is up to $125 million in FDIC insurance through the sweep network of FirstBank, subject to change at any time with notice from Meow and/or pursuant to applicable law. Terms and restrictions apply. Subject to applicable rate sheet. Interest rate on checking products quoted in Annual Percentage Yield (APY). Interest rates and yields are effective as per the date on the applicable rate sheet. See applicable terms and restrictions and refer to the applicable rate sheet for additional information.

***FDIC insurance coverage is only available to protect you against the failure of an FDIC-insured bank that holds your deposits (and does not protect you against the failure of Meow or other third party). Your account with Meow and all services provided to you are subject to the Meow Terms of Service (“Account Agreements”) and other applicable terms and no other representations or warranties, express or implied, are provided to you except as expressly set forth in those written Account Agreements. If you have any questions regarding your account, please contact team@meow.com.

FirstBank Funds Availability Notice

FirstBank’s general policy is to allow you to withdraw funds deposited in your account on the first business day after the day we receive your deposit. Funds from electronic deposits will be available on the day we receive the deposit. In some cases, we may delay your ability to withdraw funds beyond the first business day. Then, the funds will generally be available by the SECOND business day after the day of deposit.