Choosing the right structure for your business is a critical decision that you shouldn't take lightly. As an entrepreneur, you have a few compelling options with varying benefits and drawbacks. A sole proprietorship is an informal and lightly regulated setup, whereas a corporation offers some personal protections while requiring more formal processes.
Requirements to Start
A sole proprietorship is a much simpler and more efficient approach to launching a business. You typically have no formal requirements other than any local business licenses or professional licenses. If you operate a business by yourself with no formal registration, you are inherently a sole proprietor. In contrast, you must file articles of incorporation documents within your state to start a corporation. The filing includes information on the nature of the business, the initial shareholders and the role of each person involved in the start-up.
A major benefit of a corporation relative to a sole proprietorship is greater protection against personal financial liability for owners. When you operate as a sole proprietor, your business and personal finances are viewed as one in the same. Therefore, if your business owes a debt, the creditor can come after your personal holdings. With a corporation, the debts of the business are viewed as distinct from the personal finances of the owner. Therefore, creditors normally can't seek retribution from shareholders for company obligations.
Another major area of difference between a sole proprietorship and a corporation is in tax accounting. Both proprietors and corporate shareholders face some tax hurdles. Sole proprietors pay self-employment income tax, which equals 15.3 percent of business income up to $118,500 and 2.9 percent for income over that amount as of Feb. 2015. Corporations, though, face double taxation. The business earnings are taxed, and then each owner must pay taxes on his share of income distributions. One way minimize the company's tax burden is for shareholders to work as employees of the organization. In this case, the employee income is deducted from business earnings, and the employee just pays income tax on the salary.
Other Key Differences
With a corporate setup, you have increased flexibility to bring in new funds. Sole proprietors must get bank loans or restructure the business to bring in new investors. A corporation can simply issue new shares of stock to bring in equity investing. Corporations also allow for simpler transfer of ownership, as a shareholder sells his shares to another party. A proprietorship ends when the operator dies or ceases operations. A corporation's life can extend beyond the life of a founder.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.