Sole Proprietor vs LLC vs S-Corp: When Does Each Make Sense Financially?
General information, not legal or tax advice. Entity rules, fees and taxes differ by state. Talk to a qualified accountant or attorney before choosing a structure.
Most US freelancers start as sole proprietors without doing anything. The question is when, if ever, changing structure is worth the cost and paperwork. Here is the financial picture.
The three options in one table
| Sole proprietor | LLC (default tax treatment) | LLC or corporation taxed as an S corp | |
|---|---|---|---|
| Setup | Nothing required beyond any local licenses | State filing and usually annual fees | LLC or corporation plus an IRS S election (Form 2553) |
| Liability protection | None for you personally | Generally separates business debts from personal assets, if you keep finances separate | Same as the LLC or corporation underneath |
| Federal income tax | Profit goes on your personal return | Same as sole proprietor if you are the only member | Profit passes through to your personal return |
| Self-employment tax | On all net profit | On all net profit | Only on the salary you pay yourself; distributions are not SE-taxed |
| Admin | Lowest | Low to moderate | Highest: payroll, quarterly payroll filings, a separate business return |
The S corporation requirements come from the IRS S corporation page: shareholders on the personal return pay income tax at their individual rates, the company has employment-tax filings, and the election is made on Form 2553.
Where the S-corp idea comes from
SE tax is about 14 percent of profit for most freelancers (see our explainer). With an S corp, you pay yourself a salary and the payroll taxes apply to that salary, while the remaining profit is taken as a distribution. The catch is that the IRS expects the salary to be reasonable for the work you do, and you take on payroll, an extra tax return and often state fees.
A rough way to think about it
Illustrative only. At $40,000 profit the possible savings are small and easily eaten by extra costs. At $150,000 profit, the SE-tax difference can be large enough that an accountant's fees are worth paying. The crossover point depends on your state, your reasonable salary and your accountant's fees, so we do not give a single number. If you are near $100,000 of consistent profit, it is reasonable to book a consultation.
What an LLC does and does not do
An LLC mainly protects personal assets from business debts and some claims. It does not by itself lower federal taxes, and it can add state costs. It does not protect you from your own professional mistakes. Whether the liability protection is worth it depends on your risks and your state.
Decision checklist
- Do you have clients, contracts or assets that make liability protection worth paying for?
- Is your profit steady at a level where payroll costs make sense?
- Does your state charge a big annual fee for LLCs?
- Have you asked a tax professional about your reasonable salary?
Keep books from day one
Whatever you choose, separate business and personal money and keep clean records. Accounting software such as QuickBooks Online or FreshBooks helps, see the pricing comparison.