You’re at a fork in the road. This is no ordinary fork with two choices. This one has five choices. Sole proprietor, a C Corporation, an S corporation, an LLC (limited liability corporation), or an LLP (limited liability partnership) are the choices.
Tax issues and personal liability are the key issues in determining the best format for your business. Choosing sole proprietorship when you are the sole employee is the simple way to go. If you have a regular job and work on the side as a consultant, this format would let you write off expenses such as the use of computers, phones and car mileage for your consulting and maybe your home office subject to IRS rules. The big disadvantage is the lack of protection of your assets. In a dispute that could lead to a lawsuit, your personal assets are at risk. The other four forms of entity offer the protection of your assets.
If it looks like your business is going to take off, any of the other four forms would be more appropriate. They shield personal assets from suits against your business. A C corp lets you set up a medical plan. Then you can write-off all of your out-of-pocket medical expenses. If you run a sole proprietorship and file as an individual taxpayer, there are limitations on those deductions (excess of 7.5% of your adjusted gross income).
The tax rates for a young C corp with low income can be lower than those on the other four types of businesses. The first $50,000 is taxed at only 15% while the subsequent $25,000 is taxed at 25%. The third $25,000 is taxe at 34%. However, above $100,000, the tax can be as high as 39%. To lessen the high tax rate on the corporation plus the tax on a high salary, other options might be more beneficial.
An S corp, LLC or LLP might be more appropriate. All thre are similar since they are pass-through entities in which case income is only taxed once. Income flows to the individual owners. The differences have more to do with legal issues. Family businesses are often S corporations, while investments in real estate are often LLCs.