While it is easy to start your business as a sole proprietor, there are reasons why you may want to choose a different business structure. An LLC with an S election could be a good choice, depending on your expenses and liabilities. Let’s look at how a sole proprietorship stacks up vs an S Corp.
What is a Sole Proprietorship?
In North Carolina, any business that belongs to one person who sells services or goods for profit is a sole proprietorship by default. If you are married and own a business together, you can still file federal taxes as a sole proprietorship rather than a partnership.
As a sole proprietor, North Carolina does not require any formation documents be filed. If you buy and sell goods or services in NC, when tax time comes, you can pay your taxes as a business on your personal tax return without doing any official paperwork to declare yourself a sole proprietor.
However, the biggest drawback to owning a sole proprietorship is unlimited personal liability. If the company owes a debt, it is also considered a personal debt for you. Running a sole proprietorship can be a risky venture depending on your industry. If you don’t plan for personal liability, you could lose your entire business because of one client. You remain personally responsible for business debts, obligations, and liabilities as a sole proprietor.
For example, let’s say that you own an office store with 15 employees. One of your employees has a history of angry and inappropriate behavior with customers. One day, he decides to lie about and smear a customer’s name on all of the social media sites he can find. The customer sues your business for damages because she lost her job over the smear campaign tactics.
Since you knew about your employee’s previous bad behavior and didn’t do anything about it, the court could find your business at fault. If the court orders your business to pay $50,000 in damages, you will be personally liable for anything the business cannot afford to pay.
Is Your Business Vulnerable?
Often, you don’t realize where your business is vulnerable to lawsuits until it is too late. It pays to consider your business structure before starting your venture. Working with an attorney as you set up your business saves you money in the long run by preventing you from facing personal liability for business losses.
Civil lawsuits filed against sole proprietorships have many motives, including greed, fraud, actual damages, accidents, and more.
Consider these possible lawsuits before opening your doors:
- Breach of contract disputes;
- Personal injury ;
- Collection on debts or loan repayments;
- Professional negligence claims (like bad car repairs);
- Claims regarding the return of a renter’s security deposit or personal property;
- Issues with contractors or home remodels;
- Property damage claims;
- Claims involving eviction notices or lease disputes;
- Libel or slander cases; and
- Counterclaims to a lawsuit (1).
District Court handles the cases where the individual filing requests $25,000 or less. Superior Court handles cases where the individual filing requests more than $25,000. Either way, you’ll most likely incur court costs, attorneys fees, filing fees, and other hidden expenses such as expert witnesses or other expert testimony.
Alternatively, other business structures protect you personally from your business’s liability issues and obligations, keeping your private assets safe from civil lawsuits.
Positive Aspects of Sole Proprietorships
When you are the only person who owns a business, there are also some benefits to choosing a sole proprietorship business structure.
- Lack of Paperwork: you don’t have to decide on a business structure or file any paperwork with the Secretary of State to form your business;
- No planning requirements such as an Operating Agreement or Articles of Incorporation;
- Privacy: no one can look up your business in a list of incorporated companies online and see your information;
- No members, board of directors, or partners to answer to;
- No fees required to get started;
- Doing your taxes is easy. You may file a Schedule C to report your business income on your personal tax return. The IRS provides information about what forms you need to file.
What is an S Corp?
You can choose to be the sole member of a domestic limited liability company (LLC) or the sole shareholder of a corporation instead of a sole proprietor. As an LLC, you pay taxes as a pass-through entity which is similar to a Sole Proprietorship. A corporation pays taxes as a business and shareholders pay taxes personally when they receive dividends.
Alternatively, you can elect to treat the LLC or corporation as an S Corporation by choosing to make an S election using IRS Form 2553. The federal government then taxes you as an S Corp. Tax treatment in the state of NC will not change with an S election.
When you form an S Corp, you first must decide your business structure. You may choose to be either an LLC or a corporation. Then, as an LLC or corporation, you can take an S election for tax purposes. An S Corp is not a business structure; it is a federal tax designation. S Corps in North Carolina form when a corporation or LLC chooses the federal S election.
Thus, as an LLC business structure in the state of NC, you can choose to be taxed at the federal level as an S-corporation. This tax structure is called an LLC with an S election or an S Corp.
Why Choose One Over the Other?
An S Corp, either as an LLC or a corporation, protects you and your loved ones from the liabilities of your business, such as debts or lawsuits. Instead of placing the risk of liability on your own personal assets, owning an LLC can prevent you from losing your retirement funds, home, or other assets. LLCs with an S election are especially easy to set up and provide the personal protection you need in today’s litigious world.
If you are a sole proprietor who wants to minimize your personal liability, speak with your attorney about business structures and how to mitigate the risks in your particular field.
We Can Help
At Hill Law, we work exclusively in the business realm to help companies mitigate their risks, reduce personal liability, and grow their bottom line. Our experience working with startups gives us unique insight into the areas of law that apply to sole proprietorships vs S corporations. If you have questions about moving forward with your venture, contact us today and find out how we can help your business thrive.