What’s the Best Business Entity for Your Small Business?
How the Right Structure Can Save (or Cost) You Tens of Thousands of Dollars
Choosing the right business entity determines how much you pay in taxes, your personal legal risk, and your flexibility for growth. There is no “best” entity—the right choice depends entirely on your stage of business, income level, and risk exposure.
The Core Factors of Choice
The best structure for your business depends on these drivers:
- Income Level: How much net income does the business earn?
- Tax Bracket: What is your personal tax liability?
- Liability Risk: How much legal exposure does the business carry?
- Ownership: Are you operating alone or with partners?
1. Sole Proprietorship
Best for: Early-stage, low-income, low-risk businesses. If you are a freelancer or consultant receiving a 1099, you are a sole proprietor by default.
- Pros: No setup cost, no state filing, simple tax reporting (Schedule C).
- Cons: No liability protection. Your personal assets (savings, home) are at risk if the business is sued or incurs debt.
- When it makes sense: Net income is under $50,000/year and risk is minimal.
IRS Reference: Sole Proprietorships
2. General Partnership
Best for: Two or more owners with low income and low risk.
- Key Factor: Each partner is personally liable for the business and for the actions of the other partners.
- Requirement: A written partnership or operating agreement is strongly recommended.
3. Limited Liability Company (LLC)
Best for: Asset protection at any income level. An LLC is tax-neutral—it does not automatically reduce taxes. Its primary purpose is legal separation.
- Benefit: Protects personal assets from business lawsuits and debts.
- Taxation: By default, single-member LLCs are taxed as Sole Proprietorships; multi-member LLCs are taxed as Partnerships.
- When it makes sense: You have meaningful business risks or want to increase credibility with banks.
4. S Corporation (S-Corp Election)
Best for: Businesses earning $50,000–$150,000+ in net income. An S-Corp is a tax election, not a type of entity. You must first have an LLC or C-Corp.
The Tax Advantage
You pay yourself a “reasonable salary” (subject to payroll tax) and take the rest as distributions. Distributions are not subject to the 15.3% self-employment tax.
| Feature | Sole Prop / LLC | S-Corp Election |
|---|---|---|
| Self-Employment Tax | Paid on 100% of profit | Paid only on “Salary” |
| Admin Costs | Low | High (Payroll + Tax Returns) |
| Audit Risk | Standard | Slightly Higher (Salary must be “reasonable”) |
When it makes sense: Net income exceeds $75,000 to justify the added accounting and payroll costs.
5. C Corporation
Best for: High-growth, reinvestment-focused businesses ($250k–$500k+ income).
- Corporate Tax Rate: Flat 21%.
- Double Taxation: Profits are taxed at the corporate level, and dividends are taxed again at the individual level.
- The Loophole: C-Corps are powerful if you reinvest profits rather than taking them out, or if you plan to bring on outside investors.
The Evolution of Your Entity
Your business entity should evolve as you grow. It is common (and smart) to transition structures as your math changes:
- Start Simple: Sole Prop/Partnership for testing ideas.
- Add Protection: LLC once you have assets or exposure.
- Optimize Taxes: S-Corp once net income justifies the admin costs.
- Scale Big: C-Corp for massive reinvestment or venture capital.
Final Takeaway: Revisit your structure annually. In business, the margins matter, and your entity lives right there in the margins.