Sole Prop vs LLC vs S-Corp
The three options every new founder runs into, what they actually do for liability and taxes, and which one fits the stage you're in.
Whether you’re shipping a product, taking on clients, or making money under any name other than your own, an LLC is almost always the right move. That is the short version, and for the majority of women starting a business, it is also the right answer.
The longer version is that these three options are not really the same kind of thing. Sole proprietorship is the default a founder lands in by doing nothing. An LLC is a legal entity she registers with the state to put a wall between her business and her personal assets. An S-corp is a tax election, not an entity type, and it only starts saving money once the business is profitable enough to justify the extra paperwork. The rule of thumb is roughly $50,000 to $80,000 in annual net profit before the math works.
Picking the wrong structure does not feel expensive in year one. It usually shows up in year three, when a customer sues, an audit lands, or a tax bill turns out to be twice what it should have been.
The Short Answer
Stay a sole prop if you’re testing an idea with almost no revenue or risk, form an LLC the moment you’re running an actual business, and make the S-corp election once that business clears roughly $50,000 to $80,000 in annual net profit.
At a Glance
| Sole Proprietorship | LLC | S-Corp (election) | |
|---|---|---|---|
| Liability protection | None. Owner and business are the same legal entity. | Yes, if formalities are kept. Personal assets shielded from business debts and lawsuits. | Same as the underlying LLC or corporation. The election does not change liability. |
| Federal taxes | Schedule C on personal return. 15.3% self-employment tax on all profit. | Pass-through by default. Same Schedule C treatment for single-member LLCs. | Pass-through, but profit splits into salary (payroll taxed) and distributions (not subject to self-employment tax). |
| Setup paperwork | None. Selling under your own name is enough. | State formation filing, operating agreement, EIN, business bank account. | Form 2553 filed with the IRS after the LLC or corp is formed. |
| Setup cost | $0 | $50 to $500 state filing fee | $0 for the election itself, but requires an existing entity |
| Ongoing cost | $0 | $0 to $800 per year in state fees, depending on state | Payroll service ($40-$100/month), bookkeeping, tax prep ($800-$2,500/year) |
| Best for | Testing an idea with zero risk exposure | Most active DTC, freelance, and product businesses | Profitable LLCs and corps making roughly $50K-$80K+ in net profit |
Sole Proprietorship
A sole proprietorship is the structure a founder ends up in automatically the moment she sells something without registering an entity. There is no paperwork, no fee, no state filing, and no formation date. The IRS treats the owner and the business as the same person.
That simplicity is the entire upside. Income goes on a Schedule C attached to the personal tax return. Expenses get deducted on the same form. Self-employment tax, which covers Social Security and Medicare contributions, runs at 15.3% on every dollar of net profit.
The downside is significant. There is no legal separation between personal and business. If a customer is injured by a product, if a supplier sues for unpaid invoices, if a contractor files a claim over a botched project, the lawsuit reaches into personal bank accounts, savings, and home equity. A sole proprietor’s liability is unlimited.
Sole proprietorships make sense for testing an idea before any real money or risk is involved. Selling a few candles to friends. Drafting freelance work while still employed. Validating an Etsy concept with the first ten orders. Past that point, the structure becomes the cheapest decision a founder can make and one of the most expensive ones to keep.
LLC
An LLC is a separate legal entity registered with the state. Once formed, the business has its own legal existence, its own EIN, its own bank account, and its own contracts. A lawsuit against the LLC stops at the LLC, and personal assets stay out of reach.
Setup runs $50 to $500 in state filing fees, depending on the state. Texas charges $300, Florida $125, New York $200 (plus a publication requirement that can run $1,000+ in some counties). California adds an $800 annual franchise tax that hits every LLC operating in the state, regardless of revenue. Delaware charges $300 a year in franchise fees. Most other states fall between $0 and $200 annually.
Taxes pass through to the owner by default. A single-member LLC files a Schedule C, the same form a sole proprietor uses, and the IRS treats it as a “disregarded entity.” A multi-member LLC files a Form 1065 partnership return and issues K-1s to each owner. The self-employment tax (15.3%) still applies on profit, because the structure itself does not change the tax math. That is where the S-corp election comes in later.
An operating agreement is strongly recommended even for a single-member LLC. Several states (California, New York, Missouri, Maine, Delaware) require one. The document spells out ownership, voting rights, profit splits, and what happens if a member leaves, dies, or wants to be bought out. Without it, state default rules take over, and those rules often produce outcomes no founder would actually agree to.
The liability shield an LLC provides is only as strong as the separation a founder maintains. Running personal expenses through the business account, paying personal credit card bills from business funds, or treating the LLC as a personal piggy bank gives a plaintiff’s lawyer the opening to “pierce the corporate veil” and reach personal assets anyway. Courts look at commingling, undercapitalization (the business never having enough money to operate normally), and skipped formalities like the annual report or franchise tax. A few thousand dollars of sloppy bookkeeping can erase the entire reason the LLC was formed.
S-Corp
An S-corp is not a business structure. It is a tax election an LLC or corporation makes with the IRS by filing Form 2553. The legal entity stays the same. The way the IRS taxes profit changes.
Here is what the election does. Instead of paying 15.3% self-employment tax on the entire net profit, the owner splits profit into two buckets. The first is a “reasonable salary,” paid through actual payroll, and that salary is subject to payroll tax. The second is distributions, which are pulled out of the remaining profit and are not subject to self-employment tax. The savings come from shrinking the slice of income that gets hit with the 15.3%.
The math only works above a certain profit level, because running payroll costs money. A founder needs a payroll service like Gusto or ADP (roughly $40 to $100 per month), a bookkeeper or accountant who handles S-corp returns ($800 to $2,500 a year), and the discipline to actually run salary every pay period. The IRS audits S-corps more aggressively than LLCs, and the most common audit trigger is paying an unreasonably low salary to dodge payroll tax. The salary has to match what someone in the same role would earn at a comparable business.
The rule of thumb is roughly $50,000 to $80,000 in annual net profit before the savings outweigh the added cost. Below that, the payroll and accounting fees eat the tax savings. Above it, an S-corp can save a founder several thousand dollars a year. By the time net profit reaches $150,000, the savings are meaningful enough that not making the election is a real mistake.
Where Not to Form
Delaware, Wyoming, and Nevada show up in every business formation ad as the smartest states to file in. For a venture-backed startup raising on standardized term sheets, that is true. For a DTC brand doing $200,000 a year out of a home office in Ohio, it is not.
Forming out of state means hiring a registered agent in that state, paying the foreign LLC fee in the home state (because the business still operates there), and filing two sets of annual reports. The total cost can run $500 to $1,500 a year more than just forming where the business actually lives. The “tax savings” the ads promise rarely apply, because the home state still taxes the income earned by a resident.
Form in the home state unless there is a specific reason not to. The two real reasons are a venture round that requires Delaware incorporation, or a real estate holding structure that benefits from a specific state’s asset protection rules.
Common Mistakes
Assuming a Shopify store equals an LLC. Setting up a store, registering a domain, and getting an EIN does not create a legal entity. A founder operating that store without filing formation paperwork is still a sole proprietor with full personal liability.
Electing S-corp too early. A founder making $30,000 in net profit who elects S-corp status spends more on payroll fees and tax prep than she saves. The election is hard to reverse cleanly inside the same tax year, and the IRS will not refund the wasted compliance cost.
Forming in Delaware as a small DTC brand. Outside of venture-track startups, Delaware adds cost and complexity with no real benefit. The home state is almost always the right answer.
Never opening a separate business bank account. This is the single fastest way to lose the liability shield. An LLC with no dedicated bank account, where personal and business funds mix freely, gives a court every reason it needs to pierce the veil.
Skipping the operating agreement. Even a one-page agreement is better than nothing. Without one, the state’s default rules apply, and those rules rarely produce outcomes that match what the founders actually intended.
Frequently Asked Questions
Can I switch from sole prop to LLC later?
Yes. Most founders do. The process is forming the LLC, getting a new EIN for the entity, opening a business bank account in the LLC’s name, and transitioning contracts, vendor accounts, and payment processors to the new entity. The sole proprietorship effectively closes once the LLC takes over operations.
Is an LLC always better than a sole proprietorship?
For any business that has customers, employees, contractors, or inventory, yes. The liability protection is the entire reason the structure exists. The only case where sole proprietorship makes sense is the earliest test phase, when revenue is negligible and risk exposure is minimal.
Do I need an S-corp if I have an LLC?
No. Most LLCs never elect S-corp status, and many never need to. The election only saves money if net profit clears roughly $50,000 to $80,000 and the founder is willing to run payroll. A CPA can run the numbers for the specific income level.
Can an LLC own another LLC?
Yes. A holding company structure (one parent LLC owning multiple operating LLCs) is common for founders running several brands or owning real estate alongside an operating business. It adds filing complexity and is rarely worth it for a single-brand operation.
Do I need a lawyer to form an LLC?
For a single-member LLC with no outside investors, no. The state filing is straightforward, the operating agreement can be drafted from a reliable template, and the EIN application is free at irs.gov. For multi-member LLCs, complex ownership, or any business expecting outside capital, a lawyer pays for itself quickly.
This is general information, not legal or tax advice. The right structure depends on the state, the revenue, the number of owners, and the specific risks of the business. A CPA and a business attorney can review the actual numbers and recommend a plan.
Sources
- IRS, “Limited Liability Company (LLC),” irs.gov. Federal classification of LLCs and the default tax treatment for single-member and multi-member structures.
- IRS, “S Corporations,” irs.gov. Eligibility, election process (Form 2553), and ongoing requirements for S-corp tax treatment.
- IRS, “Sole Proprietorships,” irs.gov. Federal definition, Schedule C reporting requirements, and self-employment tax obligations.
- SBA, “Choose a Business Structure,” sba.gov. Small Business Administration overview comparing sole prop, partnership, LLC, S-corp, and C-corp.
- California Franchise Tax Board, “LLC Annual Tax,” ftb.ca.gov. California’s $800 annual franchise tax requirement for LLCs operating in the state.
- Delaware Division of Corporations, “Annual Report and Tax Information,” corp.delaware.gov. Delaware’s annual franchise tax obligations for LLCs and corporations.
- Cornell Law School Legal Information Institute, “Piercing the Corporate Veil,” law.cornell.edu. Legal doctrine and the factors courts use to disregard the corporate liability shield.