Sole prop, LLC or S-corp: a contractor's guide

Most home-service owners choose between operating as a sole proprietorship, forming an LLC, and later, electing to have the business taxed as an S corporation. Each choice affects your paperwork, how you're taxed and how your personal assets relate to business debts and claims, and the best answer depends on your state, your income, your risks and your plans. Use this guide to understand the basics, then make the decision with an accountant and, where liability is a concern, an attorney.

This article is general education, not legal or tax advice. Rules differ by state, change over time, and depend on your specific situation.

Why does business structure matter for a contractor?

Your structure touches several things you care about:

Liability. Whether business debts and certain claims can reach your personal assets.
Taxes. How business income is taxed and how much paperwork that takes.
Credibility. Some commercial clients, suppliers and lenders prefer working with a registered entity.
Licensing. Some state licensing boards have rules about how licenses relate to business entities, such as needing a qualifying individual for a company.
Growth. Bringing in a partner, hiring employees or eventually selling the business can be simpler with the right structure.

What are the common structures?

Here's a simplified overview. Details vary by state.

Structure	What it generally is	Typical upsides	Typical trade-offs
Sole proprietorship	You and the business are the same for legal and tax purposes	Simplest to start and run	Generally no separation between business and personal liability
General partnership	Two or more owners doing business together without forming an entity	Simple to start	Each partner may be exposed to the business's obligations; needs a clear agreement
LLC (limited liability company)	A state-registered entity that separates the business from its owners	Liability separation in many situations; flexible tax treatment	State filing fees and annual requirements; must be run as a separate business
S corporation election	A federal tax status that an eligible LLC or corporation can elect	Can change how owners' income is taxed in some situations	More payroll and bookkeeping; owners who work in the business generally need a reasonable salary
C corporation	A separate taxable entity	Suited to outside investors	More complex; often not the first choice for small trades businesses

Note that the S corporation is a tax election, not a different kind of company you register with your state. Many small business owners form an LLC, then later ask their accountant whether an S corporation election makes sense.

What does a sole proprietorship mean in practice?

If you start working under your own name without forming anything, you're generally a sole proprietor. Business income and expenses usually go on your personal tax return. You may still need a business license, a registered business name if you use one, and any trade licenses.

It's simple, which is why many owners start here. The main trade-off is liability: generally, there's no legal separation between you and the business. Insurance helps, but it doesn't cover everything.

What does an LLC change?

An LLC is formed by filing with your state. In many situations it separates business obligations from your personal assets, though that protection has limits. For example, it generally doesn't protect you from your own negligence, and it can be weakened if business and personal finances are mixed or if you personally guarantee a loan.

By default, the IRS generally treats a single-member LLC as a disregarded entity for income tax, so the income often still appears on your personal return, while a multi-member LLC is generally treated as a partnership. An LLC can also elect different tax treatment.

Running an LLC well usually means:

A separate business bank account, used only for business
Signing contracts in the LLC's name
Keeping up with your state's annual report or fees
Having an operating agreement, especially with more than one owner

When do owners consider an S corporation election?

Owners often hear that an S corporation election can save on taxes once profits reach a certain level. Whether it helps you depends on your profit, the salary you'd need to pay yourself, your state's taxes and the added cost of payroll and accounting. It's not automatically better, and the right timing is a question for your accountant, using your actual numbers.

What questions should you ask your accountant?

Bring your recent income, expected profit and plans for the next few years. Then ask:

Based on my expected profit, how would each structure affect my taxes this year and next?
Should I form an LLC now, or wait?
At what level of profit would an S corporation election start to make sense for me, given what salary would be considered reasonable in my trade?
What additional bookkeeping, payroll and filing costs would each option add?
How should I pay myself under each structure?
What estimated tax payments should I be making, and when?
How do sales tax, if it applies to my trade in my state, and use tax on materials work for my business?
What records do you need from me each month or quarter?
If I hire employees or use subcontractors, what changes?
When should we revisit this decision?

What questions should you ask an attorney?

Liability and contracts are attorney territory. Ask:

Does an LLC make sense for my risk level, and what does it protect and not protect in my state?
How should I sign contracts and quotes so they're in the business's name?
If I have a partner, what should our operating or partnership agreement include, including what happens if one of us wants out?
Does my state contractor licensing board have rules about entities and qualifying individuals?
Are there contract terms or notices my state requires for my type of work?

What should you do after choosing a structure?

Whatever you choose, a few steps apply to nearly every business:

Get an EIN from the IRS if you'll form an entity or hire employees. Many sole proprietors get one too, so they don't have to give out their Social Security number.
Open a separate business bank account. This makes bookkeeping far easier and supports any liability protection.
Update your licenses and insurance so they're in the correct business name.
Set up bookkeeping from day one. See our bookkeeping basics for contractors.
Calendar recurring filings, like state annual reports and estimated tax payments.

If you're still planning the business, our guide to writing a business plan helps you estimate the profit numbers your accountant will ask for.

FAQ

Do I need an LLC to start a contracting business? Not necessarily. Many owners start as sole proprietors. Whether an LLC makes sense depends on your risks, state and plans. Ask an attorney and accountant.

Is an S corp a type of business I register? Generally no. It's a tax election that an eligible LLC or corporation makes with the IRS. Ask your accountant whether and when it fits.

Does an LLC protect my personal assets completely? No structure gives complete protection. An LLC can separate business obligations in many situations, but there are limits. Ask an attorney in your state.

Can I change my structure later? Usually, yes. Many owners start simply and change as the business grows. Ask your accountant about the timing and any tax effects.

How ServFlo helps

ServFlo keeps the records your accountant needs: every invoice, payment and customer in one place, with reports on revenue and money owed. On the Connect plan and above, invoices and payments sync to QuickBooks Online or Xero, and time tracking with payroll export helps when you start paying yourself or employees through payroll. Every plan includes unlimited technicians. See pricing.

Sole prop, LLC or S-corp? Questions to ask your accountant