Daperis CPABusiness Entity Types Explained: Sole Prop, Partnership, LLC, S-Corp, and C-Corp
Every business structure trades off the same three things differently: how exposed your personal assets are, how the profit gets taxed, and how much paperwork you're signing up for. Here's what each one actually is, so you know which trade-off you're making before you file anything.
Sole Proprietorship
What it is: the default. If you start doing business without filing anything with the state, you're automatically a sole proprietorship, one person, no legal separation between the owner and the business.
Pros: zero cost or paperwork to start, complete control, simplest possible tax filing, your business income just goes on your personal return.
Cons: no personal liability protection at all. If the business is sued or can't pay a debt, your personal assets, home, car, savings, are exposed. It's also harder to raise money or bring on a partner without changing structure entirely.
How it's taxed: all profit passes through to your personal return and is subject to self-employment tax, currently 15.3%, in addition to regular income tax.
General Partnership
What it is: the same idea as a sole proprietorship, but with two or more owners. Like a sole proprietorship, it exists automatically the moment two or more people start doing business together for profit, no filing required, though a written partnership agreement is strongly advisable even though it's not legally required in most states.
Pros: simple and inexpensive to start, pass-through taxation, full flexibility for partners to run things day to day.
Cons: no liability protection, and it's shared. Each partner can be personally on the hook not just for their own actions but for decisions the other partners make in running the business.
How it's taxed: profits and losses pass through to each partner's personal return based on their share, reported via a partnership return (Form 1065) and a K-1 to each partner. All partners generally owe self-employment tax on their share.
Limited Partnership
What it is: a partnership with two tiers of owners. General partners run the business and take on full personal liability. Limited partners contribute money but stay hands-off and, in exchange, only risk what they invested.
Pros: a way to bring in investors who want no involvement in day-to-day management, without giving them the liability exposure of a general partner.
Cons: general partners still carry full personal liability, and it requires state filing, unlike a general partnership.
How it's taxed: pass-through, similar to a general partnership. General partners typically pay self-employment tax on their share. For limited partners, it depends on their specific role and involvement; generally, if you are truly passive, you may not owe self-employment tax, but this is always based on the facts and circumstances of your specific situation.
Limited Liability Company (LLC)
What it is: a hybrid structure that combines the liability protection of a corporation with the tax simplicity and flexibility of a partnership or sole proprietorship. It's formed by filing with the state (Articles of Organization) and can have one owner or many.
Pros: real personal liability protection as long as you keep business and personal finances properly separate, flexible management structure, and tax flexibility, since an LLC can choose how it's taxed.
Cons: state filing fees and, in some states like New York, additional requirements like publication. Ongoing compliance (biennial or annual reports) is required to keep the liability protection intact.
How it's taxed: by default, exactly like a sole proprietorship (one owner) or partnership (multiple owners), profit flows through to your personal return, subject to self-employment tax. An LLC can also elect to be taxed as an S-Corp or C-Corp without changing its legal structure at all, which is where the S-Corp comparison below comes in.
S-Corporation
What it is: not a legal structure on its own, it's a tax election that an eligible LLC or corporation can make. It changes how the entity is taxed, not its underlying legal form.
Pros: the main draw is splitting income into salary and distributions, only the salary portion is subject to self-employment tax, which can mean real savings once profit is consistently well above a reasonable salary for the work.
Cons: you have to run actual payroll, file a separate business tax return, and pay yourself a salary the IRS would consider reasonable and defensible, not just the lowest number that saves the most tax. Below a certain profit level, the added compliance cost can eat most or all of the savings. Some states or local jurisdictions, like NYC, also have their own entity tax on top of the federal picture, worth flagging here rather than assuming it away.
How it's taxed: as a pass-through entity, profit flows to the owner's personal return, but only wages run through payroll are hit with self-employment-equivalent payroll taxes. Ownership is also more restricted than a standard LLC or C-Corp: it's generally capped at 100 shareholders, one class of stock, and no non-resident alien owners.
C-Corporation
What it is: a fully separate legal and tax entity from its owners. Ownership is through shares of stock, which can be held privately or, eventually, publicly.
Pros: the strongest liability protection, the easiest structure for raising outside investment or issuing multiple classes of stock, and no restrictions on who can own shares.
Cons: double taxation. The corporation pays tax on its profits, and then shareholders pay tax again on any dividends distributed to them. It also comes with the most administrative overhead: a board, bylaws, required meetings, and more complex compliance overall.
How it's taxed: the corporation files its own return and pays corporate income tax on profits. Dividends distributed to shareholders are then taxed again at the individual level. Most small business owners don't need this structure unless they're specifically planning to raise venture capital or bring on a large number of outside shareholders.
How to Think About the Choice
Start with liability: do you need real separation between yourself and the business? If you're not sure, a good lawyer can usually walk you through that decision. The next step is to think about where your business is at and where you plan to take it in a few years. The right structure in the short term isn't always the right one long term.
Once you've figured that out, you need to look at the tax impact at the Federal, State and Local levels to make sure that your structure is the right fit for where you operate.
And last, you need to understand the ongoing compliance associated with your choice. Are you willing to do things like run payroll, file a separate return or have board meetings?
Keep It Simple / Key Takeaway 🍕
As with most business decisions, the best strategy is the one you can execute consistently. Complexity for its own sake rarely pays off; if the juice isn't worth the squeeze, simpler is often better. Ultimately, the most important step is to consult with an advisor who understands your unique situation to help you navigate these trade-offs and make an informed, educated decision.
Disclaimer: This article is for educational and informational purposes only and is not intended as financial, investment, legal, or tax advice. The author assumes no liability whatsoever in connection with its use. This content is not an exhaustive explanation of any topic, practice or process. You should always seek the advice of a licensed professional before making any accounting, tax, financial, investment or legal decision.