If you are starting a business, one of the first big decisions you will make is how to set it up. Many small business owners start as sole proprietors because it is simple. Others choose an S Corporation to save money on taxes.
But which one is better?
The answer depends on how much you make and how you run your business. Let’s break it down in simple words.
What Is a Sole Proprietor?
A sole proprietor is the easiest way to start a business. There is no separate business entity. You and your business are the same.
You report your income and expenses on your personal tax return using Schedule C.
Pros:
- Easy to start
- Low cost
- Less paperwork
Cons:
- You pay self-employment tax on all your profits
- No separation between personal and business liability
Self-employment tax is 15.3%. That covers Social Security and Medicare. And yes, it applies to all your net profit.
If your business makes $80,000 in profit, you pay self-employment tax on the full $80,000. That adds up fast.
What Is an S Corporation?
An S Corporation is not a different type of business. It is a tax election. You first form an LLC or corporation, then elect to be taxed as an S Corp.
Here is the key difference:
With an S Corporation, you pay yourself a salary. You pay payroll taxes on that salary. But the remaining profit can be taken as distributions, which are not subject to self-employment tax.
Example:
If your business makes $80,000:
- You pay yourself a $50,000 salary (pay payroll taxes on that)
- The remaining $30,000 can be taken as distributions
- You do not pay self-employment tax on the $30,000
That is where the tax savings can happen.
When Does an S Corporation Make Sense?
An S Corporation usually makes sense when your business profit is consistently over $50,000 to $60,000 per year.
If you are only making $20,000 or $30,000, the extra payroll setup, accounting, and tax filings may not be worth it.
Also, S Corporations require:
- Payroll setup
- Quarterly payroll filings
- Separate business bank accounts
- More record keeping
It is not just about saving money. It is about being ready for more structure.
Common Mistakes Business Owners Make
Here is where people get it wrong:
- They switch to an S Corp too early
- They do not pay themselves a “reasonable salary.”
- They mix personal and business money
- They do not understand payroll compliance
The IRS pays close attention to S Corporations. If the salary is too low just to avoid taxes, that can cause problems.
Saving taxes is good. Doing it incorrectly is expensive.
Which One Is Better?
There is no one-size-fits-all answer.
If you are just starting out and testing your idea, a sole proprietorship may be fine.
If your business is growing and making steady profit, an S Corporation could lower your overall tax burden.
The key is running the numbers. Not guessing.
How Local Tax in Bellflower Can Help
At Local Tax, we help small business owners decide the right structure based on their real income, not internet advice.
We can:
- Compare sole proprietor vs S Corporation for your situation
- Calculate potential tax savings
- Set up payroll correctly
- Handle bookkeeping and payroll services
- File your business and personal tax returns
If you are a small business owner in Los Angeles County and you are not sure whether you are paying too much in taxes, we can review your numbers and give you clear answers.
Local Tax
9429 Somerset Blvd
Bellflower, CA 90706
Phone: (562) 925-2203
Choosing the right business structure can save you thousands. But choosing the wrong one can cost you more. It is better to decide with real numbers in front of you.
