General information only, not legal or tax advice. Rules vary by state; confirm your choice with a qualified accountant or attorney.
This guide is for someone about to turn a side income into a proper business: a photographer taking on paid weddings, a consultant leaving a salaried job, two friends opening a small café. You have heard that you “should form an LLC” but are not sure why, or whether it is worth the cost. The structure you choose affects how much personal risk you carry, how you pay tax and how much paperwork you face each year. It is worth an hour of reading before you file anything.
The main options at a glance
The IRS notes that the most common forms of business are the sole proprietorship, partnership, corporation and S corporation, and that the limited liability company (LLC) is a structure allowed by state law. The US Small Business Administration’s guide to choosing a business structure compares them in more detail. Here is a simplified summary.
| Structure | Personal liability | How profits are taxed | Paperwork | Often suits |
|---|---|---|---|---|
| Sole proprietorship | You are personally liable | On your personal return | Minimal | Low-risk solo businesses starting out |
| Partnership | General partners personally liable | Passed through to partners’ returns | Partnership agreement; annual return | Two or more owners, low risk |
| LLC | Generally protected | Pass-through by default; can elect corporate tax | State filing and annual fees | Most small businesses with some risk |
| C corporation | Protected | Corporate tax, then tax on dividends | Highest | Businesses seeking outside investors |
| S corporation (tax election) | Protected | Passed through to owners | Corporate formalities plus payroll | Profitable businesses paying owners a salary |
Sole proprietorship
If you start selling a service under your own name and do nothing else, you are a sole proprietor by default.
The appeal
The SBA describes it as easy to form and giving you complete control. There is no separate entity to register in most places, though you may need local licences or a “doing business as” name registration.
The catch
The SBA is clear on the downside: your business assets and liabilities are not separate from your personal ones, and you can be held personally liable for the business’s debts and obligations. If a client sues or the business cannot pay a supplier, your personal savings and property could be at stake.
Tax
Profits go on your personal return, and you pay self-employment tax on net earnings.
Partnership
When two or more people run a business together without forming an entity, they are usually a general partnership by default.
The appeal
The SBA calls partnerships the simplest structure for two or more people to own a business together.
The catch
In a general partnership, partners without limited liability are personally responsible for the business’s debts, and often for each other’s business decisions. Profits pass through to the partners’ personal returns, and the SBA notes that general partners must also pay self-employment taxes.
The non-negotiable
Whatever structure two or more owners choose, write a partnership or operating agreement covering contributions, profit split, decision-making, what happens if someone wants to leave, and how disputes are resolved. Most partnership breakdowns are about these questions, not about the business itself.
Limited liability company (LLC)
The LLC is the most popular choice for small businesses that want protection without corporate complexity.
The appeal
According to the SBA, LLCs protect you from personal liability in most instances, so your personal assets, such as your vehicle, house and savings, are not at risk if the LLC faces bankruptcy or a lawsuit. By default, profits pass through to the owners’ personal returns, like a sole proprietorship or partnership.
The catch
Forming an LLC means filing with your state and paying a filing fee, and many states charge annual fees or require yearly reports. The SBA notes that LLC members are considered self-employed and must pay self-employment tax.
Keeping the protection
Liability protection is not automatic in every situation. Owners who mix personal and business money, or who personally guarantee loans, can weaken it. Open a separate business bank account, sign contracts in the LLC’s name, and keep records.
Liability protection only works if you treat the business as separate. Separate bank account, separate contracts, separate records.
C corporation
A C corporation is a legal entity separate from its owners, the shareholders.
The appeal
The SBA notes that a C corp can continue doing business relatively undisturbed if a shareholder leaves or sells shares. Corporations can issue stock, which makes them the usual choice for businesses planning to raise money from investors.
The catch
Corporations face more formal requirements, such as boards, meetings and records. Profits are taxed at the corporate level and again when distributed to shareholders as dividends, which is the “double taxation” people mention.
S corporation
An S corporation is not a separate type of business entity so much as a tax election that an eligible corporation, or in many cases an LLC, can make with the IRS.
The appeal
The SBA describes the S corp as designed to avoid the double taxation drawback of regular C corps, with profits passed through to owners. For profitable businesses, owners who work in the business pay themselves a reasonable salary through payroll, and some remaining profit can be distributed in ways that may reduce self-employment taxes. This is where an accountant earns their fee.
The catch
The SBA notes that you still have to follow the strict filing and operational processes of a corporation, and that some states tax S corps differently or do not recognise the election at all. Running payroll adds cost and admin. For a business with modest profits, the savings may not cover the extra fees.
How to decide
Work through these questions in order.
How much risk does the work carry?
A freelance copywriter working from home carries different risks from a contractor working on clients’ houses or a café serving food. Higher-risk work points towards an LLC or corporation, plus insurance.
Are there co-owners?
If yes, you need a written agreement whatever structure you choose, and an LLC is often a natural fit.
Will you seek investors?
If you plan to raise venture capital or issue shares to outside investors, a C corporation is the usual route.
How profitable is the business?
Higher, steady profits make an S corp election worth discussing with an accountant. Early on, simplicity usually wins.
What does your state charge?
Formation and annual fees differ by state. Check your state’s business filing office before deciding.
Changing structure later
Your first choice is not permanent. Many businesses start as sole proprietors, form an LLC once revenue or risk grows, and make an S corp election once profits are steady. Changing involves new filings, possibly a new EIN, updated bank accounts and contracts, so it is easier to plan the likely path from the start. Ask your accountant at what profit level they would suggest reviewing the structure, and put a reminder in your calendar.
Insurance comes first, whatever you choose
No structure replaces insurance. An LLC may protect your house from business debts, but general liability, professional liability or product liability insurance pays claims and legal costs so the business itself survives. Ask an insurance broker what your type of work typically needs.
Questions to take to an accountant or attorney
- Given my expected profit, would an S corp election save money after extra costs?
- What are the formation and annual fees in my state?
- What records must I keep to maintain liability protection?
- Do I need a federal Employer Identification Number (EIN)?
- What licences and registrations apply to my business locally?
- How should co-owners’ contributions and profit split be documented?
Business structure checklist
- Risk level of the work assessed
- Co-owners identified and agreement drafted
- Investor plans considered
- Expected profit estimated
- State fees checked
- Structure chosen and registered
- EIN obtained if needed
- Separate business bank account opened
- Insurance quotes gathered
- Accountant review booked for year one
Takeaway
A sole proprietorship is easy but leaves you personally exposed. An LLC adds liability protection with modest paperwork and suits most small businesses. Corporations make sense for outside investment, and an S corp election can help profitable owners. Match the structure to your risk, your co-owners and your profit, keep business and personal money apart, and get insurance whatever you choose.
