When you start a business, you’re faced with an important decision: what’s the right type of business entity? If you go by pure popularity, the answer is the Sole Proprietorship, which is created by default when you start doing business, and requires little to no formalities. Sole Proprietorship, like the name implies, is tied to a sole business-person, and legally, there’s no separation between the individual and his or her business. Even though Sole Proprietorships are extremely popular because they’re so simple to set up, there may be a better choice for your business. Many small businesses choose to form an LLC or an S-Corporation instead. Here are the benefits of forming an S-Corporation and how it compares to a Sole Proprietorship.

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What Is an S-Corporation?

An S-Corporation is a special type of corporation formed through filing a certificate of formation with the office of the Secretary of State where the company is headquartered, as well as the necessary tax documentation with the Internal Revenue Service. The special character of this type of corporation is derived from the fact that taxation is patterned after Partnerships, rather than Corporations. Income is sent directly to shareholders annually, and it is the shareholders who are taxed, not the Corporation. However, the Corporation itself remains a distinct, separate entity from the shareholders. When comparing Sole Proprietorships vs. S-Corporations, this legal separation is a huge benefit. Whereas a sole proprietor would have unlimited liability for business debts, in the same scenario, the S-Corporation would generally be liable, instead of the owner. That said, S-Corporations are more strictly regulated and require Corporate Bylaws, shareholder and director meetings, and more record keeping.

What Are the Pros and Cons?

In the Sole Proprietorship vs. S-Corporation debate, the answer to whether it’s more advantageous depends entirely on your unique needs. Setting up an S-Corporation requires that you put together paperwork and file documents with governmental agencies. S-Corporations may also have other ongoing filing requirements, like annual information statements. The requirements vary depending on the state where the S-Corporation is formed. By contrast, a Sole Proprietorship has none of these requirements. However, the pros may easily outweigh the time spent on extra paperwork. With protection from liability, the ability to raise capital, as well as the option for having up to 100 shareholders, forming an S-Corporation can be a very good business decision. Finally, it should be noted that S-Corporations may only be formed by U.S. citizens or resident aliens, whereas Sole Proprietorships, due to their nature, have no such limitations.

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