Sole prop vs. LLC vs. S-corp

Sole proprietor — the default

If you're self-employed and you haven't filed any paperwork to form a business entity, you are a sole proprietor by default. Congratulations, you have a business structure.

Pros: zero setup cost, zero ongoing paperwork, file taxes on a single Schedule C attached to your personal 1040, no separate EIN required (you can use your SSN). Simple.

Cons: zero liability protection. If a client sues you or you default on a business debt, your personal assets — house, car, retirement — are on the table. You also pay self-employment tax (15.3%) on every dollar of net profit, with no way to mitigate it.

Pick this if: you're just starting out, your business is low-risk (you don't have customers in your home, you don't handle other people's money or property), and you're earning under ~$50,000 net per year.

LLC — the upgrade most people should make

A Limited Liability Company is a state-registered legal entity that separates your business assets from your personal assets. For tax purposes, the IRS treats a single-member LLC exactly like a sole prop — you still file a Schedule C — but legally, your house is no longer collateral if your business gets sued.

Setup cost: $50–$500 depending on the state, plus an annual fee in most states ($25–$800/year — California is the worst at $800). Ongoing paperwork: minimal. You need a separate business bank account and you should use it consistently (commingling personal and business funds in an LLC defeats the liability protection — this is called "piercing the corporate veil").

Pick this if: you're earning more than ~$30,000/year in self-employment income, you have any kind of customer-facing risk (visiting client homes, providing professional advice, selling products), or you simply want to sleep better at night. For most freelancers and consultants, an LLC is the right move within the first year.

S-corp election — the tax-savings move

An S-corp is not a separate business structure — it's a tax election an LLC (or corporation) can make with the IRS by filing Form 2553. The election does one main thing: it lets you split your business income into "salary" (subject to the 15.3% self-employment tax) and "distributions" (not subject to it).

The catch: the IRS requires you to pay yourself a "reasonable salary" for the work you do. If you're a freelance designer pulling $150,000/year, you can't pay yourself $20,000 in salary and call the rest distributions — the IRS expects something like $80,000–$100,000 in salary.

Where it pays off: once your net profit is consistently above ~$80,000–$100,000, the S-corp election typically saves $5,000–$15,000/year in self-employment tax — even after the costs of running payroll. Below that threshold, the added complexity and payroll costs eat the savings.

Pick this if: you're consistently netting above $80,000/year, you can sustain payroll overhead (~$50–$100/month for a service like Gusto), and you don't mind the extra tax filings (separate Form 1120-S in addition to your 1040).

Decision tree — which one and when

Here's the simplest framework I can give you.

Year one of your business, earning under $30,000: stay a sole prop. The paperwork to form an LLC is not worth it yet.

Earning $30,000+ or have any customer-facing liability: form an LLC. Do it this quarter. The cost is small and the protection is real.

Earning $80,000+ in net profit consistently for 12+ months: talk to a CPA about S-corp election. The savings are real but the paperwork is meaningful, so let a professional run the math for your specific situation.

Earning under $80,000? Don't do an S-corp. The internet is full of bad advice telling small earners to "elect S-corp to save on taxes" — at low income levels, the math doesn't work and you're paying $1,000+/year in payroll fees for no benefit.