Setting Up a Business Entity: LLC, Corp or Sole Trader

For many small businesses the practical choice is between operating as a sole proprietorship and forming an LLC, with corporations relevant where outside investment or specific tax treatment is contemplated.

Sole proprietorship

This is the default when an individual operates a business without forming an entity. There is no separation between owner and business: business debts are personal debts, and a judgment against the business reaches personal assets.

It requires no formation and minimal administration. Income is reported on the owner's personal return, and self-employment tax applies to net earnings.

It suits low-risk activities with modest revenue where liability exposure is genuinely limited. Where customers visit premises, where physical work is performed, or where professional advice is given, the exposure is usually greater than owners assume.

Limited liability company

An LLC creates a separate legal entity, so business obligations generally do not reach the owner's personal assets. This protection is the main reason to form one.

By default an LLC is taxed as a pass-through: single-member LLCs are disregarded and reported like a sole proprietorship, multi-member LLCs are taxed as partnerships. Income flows to owners and is taxed at personal rates, avoiding the double taxation of C corporations.

Administration is moderate: articles of organisation filed with the state, an operating agreement, annual reports and fees in most states, and separate finances.

The liability protection depends on maintaining separation. Mixing personal and business funds, failing to observe formalities and undercapitalising the entity can allow courts to disregard the structure — commonly described as piercing the corporate veil.

S corporation election

S corporation is a tax election rather than an entity type, available to LLCs and corporations meeting eligibility requirements including limits on the number and type of shareholders.

The attraction is self-employment tax. An owner-employee pays themselves a reasonable salary subject to payroll taxes, with remaining profit distributed without self-employment tax. Where profits meaningfully exceed a reasonable salary, this can produce genuine savings.

The costs are payroll administration, additional tax filings and the requirement that salary be reasonable — an area the IRS scrutinises. The election generally becomes worthwhile only above a certain profit level, and an accountant can identify where that threshold sits for your situation.

C corporation

A C corporation is taxed separately, and distributed profits are taxed again as dividends to shareholders. It carries the most formality: bylaws, a board, meetings and minutes.

It is the standard structure where outside equity investment is intended, because investors generally expect it and because it accommodates multiple share classes. Certain benefits and specific tax provisions may also favour it in particular circumstances.

Practical formation matters

Form in the state where you actually operate. Forming elsewhere generally requires registering as a foreign entity in your home state anyway, producing two sets of fees and filings without benefit for most small businesses.

Obtain an EIN, open a dedicated business bank account, and keep finances entirely separate. Check licensing requirements at state, county and municipal level, which are easy to overlook.

Beneficial ownership reporting requirements under the Corporate Transparency Act have been subject to litigation and changing guidance, so confirm current obligations rather than relying on older information.

Insurance still matters

Entity structure does not replace insurance. It does not protect against your own negligent acts, and professional liability, general liability and other coverages remain necessary.