Business Structure 101: LLC, S-Corp, or Sole Proprietor?

Congrats! You've decided to take the plunge into freelancing, and now, someone (probably the internet) has told you that you need to choose a business structure: should I be a sole proprietor, LLC, or S-Corp? The internet is full of conflicting advice, and everyone seems to have strong opinions about which structure is "best".

Here's what most people don't realize: this decision matters less than you think, and you're probably overthinking it. For most freelancers, the real choice is between sole proprietorship and LLC. While S-Corp appears in every "business structure" article, S-Corp as a legal entity (not just a tax election) involves governance requirements that are typically unnecessary unless you're planning to bring in investors or multiple owners.

The choice between sole proprietor and LLC is really about liability protection versus annual costs. That's it. You don't need to make this decision right now. There's nothing wrong with sticking with sole proprietorship if you are not sure.

Let me walk you through the practical realities of each option so you can make an informed decision and get back to focusing on your actual business.

Disclaimer: This is general information only. Every person and every business is different. It's best to talk to your CPA or attorney if you're worried about your decision or have specific concerns about your situation.

Understanding the Basics: Legal Entity vs. Tax Election

Before we dive into which option is right for you, it's important to understand that business structure involves two separate decisions: your legal entity type and your tax type. These are different choices, and many people get confused thinking they are the same thing.

Legal Entity Types:

• Sole Proprietorship: You and your business are the same legal entity

• LLC (Limited Liability Company): Your business is a separate legal entity from you personally

• S-Corp (Corporation): Your business is a separate legal entity with more complex governance requirements

Tax Types:

• Sole Proprietorship: Business income flows through to your personal tax return

• S-Corporation: You can elect to have your LLC or corporation taxed as an S-Corp

While there are other business structures available, these are the most common for freelancers.

This post focuses on the legal entity decision: sole proprietorship vs LLC. Tax elections are a separate topic we'll dive into a future post.

The important thing to understand: forming an LLC changes your legal structure only. You'll still be taxed as a sole proprietor by default unless you make an S-Corp tax election. The legal protection and tax treatment are separate decisions.

For most freelancers, the governance requirements and complexity that come with an S-Corp legal entity aren't worth it unless you are planning to bring in investors or multiple owners. The real decision is usually between sole proprietor and LLC for your legal structure, with the option to elect to be taxed as an S-Corp later, if it makes sense financially.

Starting Simple: The Sole Proprietor Route

When you start freelancing, you are automatically a sole proprietor unless you actively choose otherwise. This is the simplest business structure possible, which is why it's perfect for testing the waters.

How sole proprietorship works: You and your business are the same entity in the eyes of the law. Your business income gets reported on your personal tax return using a Schedule C form. You'll need to pay self-employment taxes, but there are no separate business tax filings or additional fees beyond what you would normally pay.

The advantages are simplicity and cost. No registration fees, no annual state fees, no separate tax returns. You can start earning money today and worry about more complex structures later. If you're still testing whether freelancing works for you, this keeps your overhead minimal.

The downside is liability. Since you and your business are legally the same entity, your personal assets are on the line if your business gets sued or incurs debt. If a client decides to sue you for a million dollars (however unlikely), they could potentially go after your house, car, and personal savings.

This structure makes sense when: You're just starting out, testing freelancing part-time, or providing low-risk services where lawsuits are unlikely. If you're a freelance writer, graphic designer, or consultant providing advice, the liability risk is generally lower than if you're doing something like home renovation or financial planning.

Sole proprietorship can work long-term. There's nothing wrong with staying as a sole proprietor indefinitely. I know successful full-time freelancers who have continued with sole proprietor status for both their legal entity and tax type. It's a perfectly valid choice if it works for your situation.

The Next Step: Limited Liability Company (LLC)

An LLC creates a separate legal entity from you personally, which provides liability protection. If you form an LLC, you'll still be taxed as a sole proprietor unless you make a separate election to change your tax status later.

How LLCs work: Your business becomes its own legal entity, which means there's a layer of protection between your personal assets and any business liabilities. If someone sues your LLC, they generally can't go after your personal house or savings account.

Costs vary by state. You'll pay a one-time registration fee when you set up the LLC (usually $50-$300) and then an annual fee to maintain it (typically $50-$500, depending on your state). Some states, like California, have higher fees, while others, like Wyoming, are significantly cheaper.

Tax flexibility is another advantage. If you start as an LLC, you can easily elect S-Corp taxation later. If you stay as a sole proprietor and later want S-Corp taxation, you'd need to first form an LLC, then make the tax election, which takes a bit more time.

LLCs make sense when: You're going full-time with freelancing, you provide services where liability is a concern, you can afford the annual fees, or you simply want the peace of mind that comes with separation between business and personal assets.

Keep in mind that an LLC provides a layer of protection but isn't bulletproof. You'll still want business insurance to fully protect yourself, which we'll cover in a future post.

How to Decide: The Practical Factors

The choice between sole proprietor and LLC really comes down to a few key considerations:

Your service type matters. If you are providing a low-risk service, staying as a sole proprietor longer might make sense. If you're doing anything where mistakes could be costly or you're working with larger contracts, the liability protection becomes more valuable.

Your risk tolerance is personal. Some people sleep better at night knowing they have that extra layer of protection, even if the statistical likelihood of needing it is low. Others prefer to save the annual fees and take the minimal risk. Neither approach is wrong.

The cost factor varies dramatically by state. In some states, an LLC costs $50 per year to maintain. In others, it's $500+. Look up your specific state's fees before making the decision. If you're in a high-fee state and money is tight, waiting until you're more established makes perfect sense.

When to Make the Switch

In my experience, the best time to move from sole proprietor to LLC, for most people, is when you decide to go full-time with freelancing. At that point, you're committed to the business, you hopefully have steady income, and the annual fees become a reasonable business expense rather than a burden.

That said, there's no magic income threshold or timeline. I've seen people start with an LLC from day one because they wanted the protection. On the other hand, I've seen successful freelancers stay as sole proprietors for years because it makes sense to them.

The key thing to remember is that nothing is set in stone. If you start as a sole proprietor and later decide you want the protection of an LLC, you can set one up at any time. If you end up getting a full-time job and don't need the LLC anymore, you can dissolve it.

The Bottom Line: Don't Overthink It.

If you decide to form an LLC, the process is simpler than it sounds and you can handle it yourself in most states. We'll cover the step-by-step process in a future post.

Here's my honest recommendation: if you can afford the annual cost in your state, go ahead and set up the LLC. The liability protection is worth the peace of mind for most people, and the cost is tax-deductible as a business expense.

If the annual fees feel prohibitive right now, start as a sole proprietor and revisit the decision later. You're not locked into anything permanently.

The biggest mistake I see people make is spending weeks researching business structures instead of focusing on finding clients and building their business. Your business structure won't make or break your success. Your ability to deliver value to clients and manage your finances well will.

What questions do you have about choosing your business structure? Are there specific concerns about liability or costs in your field that you're trying to work through? I'd love to help you think through your particular situation and make sure you're making the best choice for where you are right now.