Yes, operating a business as a sole proprietor or general partnership offers simplicity, but that comes at the cost of not having a separation between you as an individual and your company. Are there other options? There are alternate options that include popular entity types like the Limited Liability Company, C Corporation, and S Corporation.

For entrepreneurs who want to protect their personal assets and have tax flexibility, registering as a legal business entity, such as an LLC, oS Corpo, or C Corp, is well worth exploring. Continue reading because I’m going to break down the basics of the LLC vs. S Corp vs. C Corp, so you gain some knowledge of what they have to offer.

Keep in mind that what I share here is for informational purposes only and is in no way meant as legal or tax advice. You should consult an attorney and accountant or tax professional to ensure you understand your options as you decide which structure will be best for your business.

Limited Liability Company

What is an LLC?

The Limited Liability Company (LLC) business structure has become popular with many small business owners. It is less complicated and less costly to establish and maintain than a corporation, and it limits personal liability and provides tax treatment flexibility. If being a sole proprietor or partner isn’t giving you peace of mind, becoming an LLC offers some of the benefits that corporations enjoy—without the complexity.

Forming an LLC

To form an LLC, you need to file Articles of Organization with the state in which you wish to operate your business. Although most states don’t require it, I suggest also creating an operating agreement for your LLC—especially if you have more than one owner. An operating agreement will define the responsibilities and roles of owners, so you can avoid misunderstandings about how your company should be managed.

Protection Against Personal Liability With an LLC

When you form an LLC, you legally separate your personal self from your business. So, if someone sues your company or you cannot pay your business debts, plaintiffs and creditors generally may not seek your personal assets as restitution.

Tax Flexibility With an LLC

Whether your LLC has a single owner or multiple owners, it has two tax treatment options:

1. Pass-through tax treatment – By default, your LLC will be taxed in the same way as a sole proprietorship or general partnership. For tax purposes, the IRS will view your company as a disregarded entity. In other words, all income and profit or loss will pass through directly to your personal income tax return.
2. S Corporation tax treatment – If you elect for your LLC to have S Corp tax treatment, your business income/losses will flow through to your personal tax return, too. But the difference is you will only pay self-employment taxes (Social Security and Medicare) on your owner’s wages and salaries, not on all income.

LLC Ownership and Management Flexibility

Many states allow individuals (including non-residents of the U.S.), corporations, other LLCs, and groups to form an LLC. If your business has multiple owners, you have the freedom to allocate percentages of your LLC’s profits and losses among owners as you see fit. As a multi-member LLC, you can opt to be either member-managed or manager-managed. A member-managed LLC gives all the authority over making decisions, signing contracts, and managing operations to the owners of the LLC. A manager-managed LLC is one in which members elect a manager or managers to run the business operations and have a certain degree of decision-making authority. In this management structure, the owners will often retain the authority to make important decisions, enter into contracts, and fulfill other duties. Unless specified in your formation documents, in most states, your LLC will by default be considered member-managed.

Compliance Responsibilities of an LLC

A nice LLC perk is you’ll have less complicated ongoing compliance responsibilities than if you register as an S Corporation or C Corporation. As an LLC, you won’t have to elect officers and directors to oversee your business. You will have some ongoing compliance tasks to stay in good standing with the state, though. I encourage you to do your homework to learn what they are, so you’re not caught off-guard and risk losing your status as an LLC.

Potential Downsides of an LLC

As with all business entity types, the LLC has some disadvantages to consider. An LLC may not issue company stock, so you’ll have fewer ways than an S Corporation and C Corporation to raise capital. Also, investors may perceive your business as a less reliable investment than a corporation. Another downside to an LLC is that self-employment taxes will typically apply to all your business earnings, not just the money you take as personal draws.

S Corporation

What Is an S Corporation?

The S Corporation isn’t a legal business entity type in and of itself but rather a special election made by either an LLC or C Corporation with the IRS.

Personal Liability and the S Corporation

Because your business is formed as either an LLC or C corporation, it’s considered a legal entity separate from its owners. That means owners’ personal assets have protection against lawsuits and debts of your company.

Income Tax and the S Corporation

An LLC or a Corporation that chooses an S Corp election will have its profits and losses flow through to its shareholders (owners), who then report them on their personal income tax returns. Like an LLC, your business will not pay federal taxes at the corporate level. But unlike an LLC, not all income is subject to self-employment taxes—only owners’ salaries are.

Compliance Responsibilities of an S Corporation

When a business elects S Corporation status, many of the requirements it needs to meet are standard for its underlying business structure. You should check with your state and make sure you understand your obligations as either an LLC or Corporation with S Corporation election.

Potential Downsides of an S Corporation

If your business is a C Corporation choosing to be treated as an S Corp, you may only have up to 100 shareholders, and you can issue just one class of stock. That could limit your ability to raise capital. Also, your shareholders must be either citizens or permanent residents of the U.S. United States.

For an LLC, another drawback is higher formation costs and more compliance complexity.

C Corporation

What Is a C Corporation?

Although more complicated to operate, a C Corporation provides the most personal liability protection for shareholders in a company. The IRS considers a C Corporation an independent taxpayer and associates its income and expenses with the business, not its owners (shareholders). Ownership of a C Corporation is established through issuing shares of stock, either held privately or publicly.

Forming a Corporation

To register as a C Corporation, you must file Articles of Incorporation with the state in which you want to operate your business.

Taxes and the C Corporation

A C Corporation (unless it files for the S Corporation election) must pay federal income tax on company profits at the corporate tax rate. In some circumstances, the corporate tax rate may be lower than paying the individual tax rate on business profits (as with an LLC). As a C Corp, your company may be eligible for tax deductions not available to other business structures.

C Corporation Ability to Sell Stock

A C Corporation has more potential to raise capital and grow. It can issue multiple classes of stock, and it may have an unlimited number of shareholders.

Longevity of a C Corporation

Unlike with a sole proprietorship (and in the case of some LLCs), a C Corporation will survive beyond its owners’ life spans. You can transfer a C Corporation’s ownership interests by selling, bequeathing, or gifting shares of stock to others.

Compliances Responsibilities of a C Corporation

A C Corporation has more compliance requirements than other business entity types. To retain the benefits of its corporate status and stay in good standing with the state, a C Corporation must follow internal and external corporate rules. Some of the requirements may include adopting bylaws, submitting annual reports to the SEC (U.S. Securities and Exchange Commission), holding shareholder and board of director meetings, and others.

Potential Downsides of a C Corporation

Double taxation (when profits are distributed to shareholders as dividends are taxed again at the individual tax rate on shareholders’ tax returns) deters many small businesses from becoming a C Corporation. The higher business registration costs and more rigorous compliance requirements also may be more than a small business will want to bear.

Remember Ongoing Business Compliance

Regardless of the business entity type you choose, to stay in good standing with the state and maintain the legal protections and tax advantages of that structure you will also need to:

• Keep business licenses and permits current.
• Submit your annual report to the state.
• Notify your state of changes to your business.
• Maintain a registered agent.
• Keep your business and personal finances separate.
• Pay income tax, sales tax, and payroll taxes.

Again, different states have different rules, and requirements can vary depending on the nature of what a business does.

What’s Right for Your Company?

Which business entity type will benefit you and your company? With so much to think about, I recommend talking with an attorney who has expertise in business law and consulting an accountant or tax advisor. The legal and tax considerations associated with selecting an LLC vs. S Corp vs. C Corp can affect your business financially, administratively, and operationally.

Many freelance professionals and independent contractors operate as Limited Liability Companies (LLCs). The requirements for when a business should send a 1099 form to an LLC vary, as does the 1099 form to send.

Generally speaking, this is when LLCs should or should not receive a 1099:

• When a single-member LLC is taxed as a Sole Proprietorship or a multi-member LLC is taxed as a Partnership, any business that pays the LLC $600 or more for services in the year must send it a 1099-NEC (Nonemployee Compensation) form.
• If a business has sold $5,000 or more of consumer products to an LLC for resale, it may send Form 1099-NEC or 1099-MISC.
• If an LLC is taxed as an S Corporation or a C Corporation, no 1099 is necessary under most circumstances.

Let’s look a little more closely at the various 1099 forms and their usage.

How Do You Know if an LLC Needs a 1099?

The name of a Limited Liability Company alone won’t tell you if it’s taxed as a disregarded entity (Sole Proprietorship or Partnership) or a C Corporation. So how can you know whether a 1099 form is necessary? Request a W-9 (Request for Taxpayer Identification Number and Certification) form.

Along with other pertinent information, Form W-9 requests the vendor’s federal tax classification. If S Corporation or C Corporation is noted on the form, then it’s likely no 1099 will be required.

1099-NEC vs. 1099-MISC

The two most commonly issued 1099 forms to self-employed individuals (including owners of LLCs) are the 1099-NEC and 1099-MISC. Both are considered “information returns,” as they supply details to support what the issuing businesses and self-employed recipients report on their tax returns. You can find a complete list of the types of payments reported on those forms and other details on the IRS’s website. Below, find an overview of each form’s purpose and a list of common situations when the IRS requires one or the other.

Types of 1099-NEC Payments

The 1099-NEC is used mainly for reporting compensation of $600 or more for services rendered.

Examples of 1099-NEC Usage:

• Compensation for services provided, which may also include payments for materials the LLC used to perform the services.
• Payment for professional services provided by providers such as attorneys, architects, engineers, accountants, freelance writers, and graphic designers.
• Commissions paid to contracted salespeople.
• Direct sales of $5,000 or more in consumer products to the recipient for resale (this may instead be reported on Form 1099-MISC).

Types of 1099-MISC Payments

Form 1099-MISC is used for reporting payments to self-employed individuals (owners of LLCs included) for various incomes not captured on 1099-NEC.

Examples of 1099-MISC Usage:

• Payment of $10 or more for royalties or broker payments.
• Payment of $600 or more in rent, prizes or awards, payments (such as settlement fees) connected with legal services (but not for an attorney’s services).
• Payment of $5,000 or more in direct sales of consumer products to the recipient for resale (this may instead be reported on Form 1099-NEC).

Deadlines for Sending 1099s to LLCs

The IRS has due dates for when 1099 forms must be filed so that recipients receive them in plenty of time before their tax return filing deadlines.

• 1099-NEC Filing Due Date – Forms must be furnished to recipients and filed with the IRS by January 31 whether filed by paper or electronically.
• 1099-MISC – Forms must be furnished to recipients by January 31* and filed with the IRS by February 28 if filed by paper or March 31 if filed electronically.

If a due date falls on a weekend or holiday, the IRS moves the deadline to the next business day.

Along with copies of all the 1099 forms a business has sent to recipients, it must also submit Form 1096 (Annual Summary and Transmittal of U.S. Information Returns) if filing paper forms by mail. If using the IRS Filing Information Returns Electronically (FIRE) system, form 1096 is not required.

*Deadline is February 15 for forms reporting gross proceeds of at least $600 paid to attorneys or substitute dividends and tax-exempt interest payments reportable by brokers.

What Happens if You Don’t Send a 1099 to an LLC that Needs One?

There are penalties for each information return that is filed late or not sent. The charges vary depending on the lateness of the filing and whether the business intentionally ignored its responsibility. The business required to send the 1099 forms is the one that receives the penalty. Vendors and contractors are not held responsible if their clients fail to send a 1099 to them as long as they still report their income to the IRS despite not receiving a 1099.

In some cases, the IRS may grant an extended due date for filing 1099-NEC and 1099-MISC forms. An extension must be requested by filing Form 8809 (Application for Extension of Time to File Information Returns), and the filer must meet one of the following criteria:

• Suffered a catastrophic event in a federally declared disaster area, making it not possible to resume operations or obtain necessary records
• Death, serious illness, or unavoidable absence of the individual responsible for filing
• Fire, casualty, or natural disaster which affected the filer’s operations
• In the first year of operating the business
• The filer did not receive data on a payee statement in time to prepare an accurate information return

Where to Turn for Assistance With 1099s

Because failing to send 1099 forms, sending the wrong forms, or completing forms inaccurately can create confusion and inconvenience for your vendors and cause additional costs for you, it’s important to handle them correctly. I encourage you to talk with your tax advisor or accountant about any 1099 responsibilities you must fulfill now and to keep up with any changes the IRS makes in the future.

Many entrepreneurs who are the sole owners of their business (or operate a business with their spouse) choose to operate as sole proprietorships. A sole proprietorship is the simplest business structure to manage, which is why it’s popular with self-employed individuals. The sole proprietor (business owner) and the sole proprietorship (the business) are considered the same legal entity and tax-paying entity. The structure has no ongoing entity compliance formalities because it’s not a registered state entity. And tax preparation is typically easier than with other structures as business-related income and expenses flow through to the owner’s individual tax return.

Unfortunately, the simplicity of running a sole proprietorship comes with some disadvantages. The most significant is the business owner’s unlimited personal liability for the legal issues, debts, and expenses of the business.

How can sole proprietors protect their personal assets? One way is to purchase sole proprietorship liability insurance or other business insurance policies to help cover certain costs if the business encounters unfortunate circumstances.

Risks of Operating as a Sole Proprietorship

Before I discuss some types of insurance that sole proprietorships may benefit from, I want to highlight some of the risks that sole proprietors face.

With no legal separation between the business and its owner, any legal problems and financial debts of the company are those of the business owner, too. That means the owner’s personal assets (house, car, savings accounts, etc.) could be seized to pay outstanding debt to creditors, money owed to vendors, or court-awarded damages to customers if the business does not have the necessary assets.

Examples of things that could put a sole proprietorship’s business owner’s personal assets at risk include:

• Damage to a customer’s property
• Employee on-the-job injuries
• Lawsuits
• Inability to pay business creditors and vendors
• Failure to pay business-related taxes
• Lack of funds to pay business loans
• Data breaches that compromise customer information

Also, sole proprietors will likely have to dip into their personal checking and savings accounts to cover any of costs related to their own business’s loss or theft of inventory, damage to business property, data recovery if affected by a breach, or other disasters if they don’t have sufficient company funds.

Business insurance policies that cover those types of circumstances and related costs can help protect sole proprietors’ personal assets.

What Kind of Insurance Does a Sole Proprietor Need?

Various types of insurance policies exist to help sole proprietors protect their business and personal assets. Below you’ll find overviews of several types of insurance business owners may want to consider. What a policy’s coverage includes or does not include may vary depending on the insurance provider and other factors.

It’s important to note that insurance policies can help cover costs (or lost revenue) associated with lawsuits, property damage, and injuries to others. However, they do not remove the sole proprietor from being held responsible for legal and financial claims against their business. Only a business owner with more formal entities (such as an LLC or corporation) can protect personal assets from liability litigants and creditors.

1. General Liability Insurance

General liability insurance helps protect business assets in the event of common liability risks when dealing with customers, vendors, or other third parties. These basic liability policies can help cover the costs associated with claims of bodily injury, property damage, defective products, and personal injury (e.g., slander and libel).

2. Professional Liability Insurance

Professional liability insurance (also known as errors and omissions insurance) covers actions (or inactions) of business owners who offer professional services to clients.

Professions that may benefit from professional liability insurance:

• Consultants
• Engineers
• Accountants
• Bookkeepers
• Real estate agents
• Marketing and advertising firm owners

If someone sues the business for mistakes, professional negligence, bad advice, misrepresentation, copyright infringement, failure to fulfill contracted services, or similar claims, professional liability insurance can help pay for legal fees, court-ordered damages, and lost income if unable to work while attending a trial.

3. Commercial Property Insurance

A commercial property insurance policy can help cover the costs of repairs or replacements if the business’s office, equipment, or inventory gets damaged, destroyed, stolen, or lost due to weather (e.g., lightning, hail, wind), vandalism, theft, fire, smoke, and possibly other unanticipated circumstances.

Items typically covered by business property insurance:

• Buildings
• Furniture
• Office equipment
• Tools
• The sole proprietor’s personal property

Note that some types of disasters, such as floods, nuclear hazards, earthquakes, acts of terrorism, are often excluded from commercial property insurance policies. Some insurance companies offer special riders to extend coverage to damages not included in their standard business property insurance policy.

4. Business Interruption Insurance

With a business interruption insurance policy, a business owner can receive compensation for some of their lost income if they must stop or slow down operations due to an insured disaster, burglary, or act of vandalism.

Examples of lost income and operating expenses typically covered by business interruption insurance:

• Lost revenue (based on what the business would normally take in if it were open)
• Payroll for employees
• Mortgage and other loan payments
• Rent and lease payments
• Tax obligations
• Costs for relocation

There’s usually a waiting period (e.g., 48 hours or 72 hours) before a business interruption insurance policy’s lost income benefits kick in.

5. Cyber Insurance

With so much business conducted on computers, online, and through software applications, the risk of data breaches and other cyber security threats that lead to losses for companies and their customers has escalated to alarming levels. Some insurance companies offer different variations of cyber insurance (e.g., cyber liability insurance and data breach insurance) or provide coverage in a single policy to help cover legal fees, expenses, and losses.

Examples of losses covered by cyber insurance:

• Cyber attacks (such as viruses and ransomware)
• Phishing schemes
• Fraud
• Breaches of personally identifiable data
• Cyber extortion
• Other

If a business encounters any of those unfortunate circumstances, a cyber insurance policy can help compensate the company for lost revenue and cover costs associated with notifying customers in the event of a breach, repairing their computer network, recovering data, and other aspects of restoring operations and regaining customer trust.

6. Business Owner’s Policy (BOP)

A business owner’s policy (BOP) will bundle several types of insurance to provide comprehensive protection under one policy.

Typically, insurance carriers offer two or more of the following types of coverage in their BOP packages:

• General Liability Insurance
• Commercial Property Insurance
• Business Interruption Insurance

Note that many providers have eligibility requirements (e.g., must be under a certain dollar amount in annual revenue, have no more than a specific number of employees, or aren’t involved in a specific industry).

7. Employment Practices Liability Insurance

Employment practices liability insurance (EPLI) covers legal costs resulting from legal claims related to a business’s employment practices, often those involving the violation of workers’ or job applicants’ rights.

Examples of legal issues covered by employment practices liability insurance include:

• Discrimination (e.g., race, gender, age, religion, disability)
• Sexual harassment
• Privacy violations
• Defamation (libel or slander)
• Failure to promote
• Breach of an employment contract
• Wrongful discipline or termination
• Mismanagement of benefit plans (e.g., retirement, health savings)

8. Workers’ Compensation Insurance

If a sole proprietor hires employees, workers’ compensation insurance may be required by the state (rules vary by state). Workers’ compensation insurance policies cover lost wages and medical costs associated with injuries and illnesses that are work-related.

9. Commercial Umbrella Insurance

Some insurance providers also offer umbrella policies that supplement other business liability policies. An umbrella policy extends coverage limits of other policies in the event there’s a shortfall and the other liability policies won’t cover what the business owes. The liability policies to which umbrella policies apply vary depending on the insurance company, but most do not include commercial property insurance.

Is It Better to Register an LLC or Purchase Business Liability Insurance?

That’s a difficult question to answer with a yes or no because it doesn’t involve an apples-to-apples comparison.

Registering a Limited Liability Company creates an official business entity in the state. The LLC is legally separate from the business owner. Therefore, unlike a sole proprietor, an LLC owner (member) is generally not held responsible for the debts of and legal actions against the business.

A sole proprietorship liability insurance policy may cover some of the costs and losses associated with business risks that become realities for a sole proprietor. However, the business owner is still legally and financially responsible for any claims against the sole proprietorship. If insurance doesn’t cover all the costs, the sole proprietors’ personal assets may be at risk.

Conversely, an LLC member’s personal assets are protected by the fact that the business is its own legal entity. So, even if someone sues the LLC or the business owes creditors money, under most circumstances (with some exceptions such as owner negligence, fraud, or harmful acts) the owner’s personal property and funds cannot be taken to settle the legal damages or pay off debts.

That said, in addition to registering a business as an LLC, it may also be beneficial to seek certain business insurance policies to help cover business costs and further protect personal assets in the event of the unthinkable.

How Much Does Sole Proprietorship Liability Insurance Cost?

The annual cost of sole proprietorship liability insurance can vary widely from hundreds of dollars to thousands of dollars.

Below are some of the factors that influence the cost of business insurance premiums:

• The insurance provider
• The type of business insurance policy
• The industry or line of work and its inherent risks
• Whether or not the business has employees or outsources work to independent contractors
• Where the business is located
• The deductible

Fortunately, for business owners who want to cover their personal assets as well as their business assets, forming an LLC is relatively inexpensive. State’s pricing and requirements vary. The one-time filing to register the entity with the state isn’t exorbitant (in some states, it’s under $100), and LLCs have few ongoing compliance responsibilities.

Choosing the Right Business Insurance Provider and Policies

Although insurance companies may use the same name for their types of policies, not all policies offer the same level of coverage. That’s why it’s imperative for sole proprietors to take the time to research providers and talk to other business owners in their field for recommendations on companies that have fulfilled their needs. Finding a knowledgeable, reputable agent capable of understanding the complexities of the business is essential because different industries and types of business activities have different types and degrees of risk.