The Pros & Cons of a Sole Proprietorship & Corporation

by John Cromwell

Selecting the appropriate organizational type is one of the most important decisions you will make when starting your own business. Two popular organizational types are sole proprietorship and corporation. Which organization is best for you depends on your business’s circumstances. The interesting thing about comparing sole proprietorships and corporations is that, in many ways, the pros of one are the cons of the other, and vice versa.

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Number of Owners

A sole proprietor, by definition, is a business with one owner who cannot transfer the business to another person. A corporation, on the other hand, can have multiple owners who can transfer their shares in the business to others. This means a sole proprietorship has a finite life since it can only last for as long as the sole proprietor is alive, while a corporation could exist forever.

Liability

Another key difference is how the business’s liabilities are treated. For a sole proprietorship, the owner is personally responsible for all of the business’s debts. If the business lacks the funds to pay its obligations, the owner has to pay using his personal assets. On the other hand, a corporation’s shareholders generally are not personally liable for the business’s debts; if the business cannot pay its debts, the creditors usually cannot sue the shareholders.

Income Tax

When a sole proprietorship earns income, the owner includes it on his personal income tax return for that year. In contrast, corporate income is essentially taxed twice. The corporation pays taxes on income it earns in the year it is earned. Then, when the income is distributed to its shareholders as dividends, the shareholders also pay tax on the income.

Control of Business

With a sole proprietorship, the sole owner is generally also the manager of the business, which means the owner can make most decisions regarding the business on his own. A corporation, on the other hand, has a rigid managerial structure. Shareholders have only the ability to vote on significant business events, such as mergers and the election of directors. Directors can make only broader strategic decisions and appoint the corporate officers who run the day-to-day operations. This segregation of responsibilities makes it difficult for any one person or small group of people to run the business.

Self-Employment Tax

If a person has a sole proprietorship, he must pay self-employment tax on the entirety of the business’s proceeds. This means the sole proprietor must pay a 13.3 percent tax on all income earned by the sole proprietorship in addition to income tax. A shareholder of a corporation does not have to pay self-employment tax on corporate income. If he happens to work for the corporation, he and the corporation would be responsible for the same payroll taxes that are applied to all corporate employees.

How to Choose

If you wish to get advice specific to your business’s circumstances, consider consulting with a legal adviser. However, in general terms, if you want to obtain investment for you business, you may wish to incorporate your business. On the other hand, if you only want to participate in a small business that does few sales of products that do not have a huge risk of liability, a sole proprietorship might be a better option.