Many small business owners begin as sole proprietors—it’s simple, inexpensive, and offers complete control. You report income and expenses on your personal tax return, and filing remains straightforward. But as your business gains traction, that simplicity can create blind spots—most notably in liability exposure, tax burdens, and growth potential.

At some point, it becomes worth considering whether forming an LLC or electing S‑Corp status might bring meaningful benefits. These entities introduce structure, protection, and potential tax savings—but they also add complexity. Understanding when and why to make the switch is key. Here’s a closer look.

Why Going Beyond the Sole Proprietor Makes Sense

As a sole proprietor, your business isn’t legally separate from you. If your business is sued or unable to pay its debts, your personal assets—like your savings or your home—are at risk. Transitioning to an LLC or S‑Corp creates a legal entity that offers limited liability protection, insulating your personal assets from business liabilities.

Tax-wise, today’s pass-through structures also offer advantages. The Tax Cuts and Jobs Act allows a 20 percent qualified business income (QBI) deduction on eligible income from pass-through entities, which includes LLCs and S‑Corporations. This can substantially reduce your effective tax rate, especially if your business is thriving.

When It’s Time to Consider an LLC

Forming an LLC is often the first step in evolving your sole proprietorship without drastically changing your operations. A single‑member LLC is generally treated as a “disregarded entity” for tax purposes—so you still report income on Schedule C, with no double taxation, but also get the liability shield that coincides with an LLC.

This structure is especially appealing when:

• Your business risk profile is increasing—say you’re dealing with customers, contracts, or inventory.
  
  
• You want the flexibility to grow or take on partners later.
  
  
• You’re ready to formalize your business identity.
  
  

LLCs also offer operational simplicity compared to corporations: fewer meetings, less strict formalities, and more flexibility in allocating profits.

When an S‑Corp Tax Election Makes Sense

Once your income has grown—typically above $40,000–$50,000 net profit—the S‑Corp tax election can help you save money. That’s because you can split your profits between a reasonable salary (subject to payroll taxes) and distributions (which are not).

For example, if your business nets $100,000:

• As a sole proprietor or LLC, the full amount is subject to 15.3 percent self-employment tax.
  
  
• With S‑Corp status, you might pay yourself a $60,000 salary (subject to payroll tax), and take the remaining $40,000 as distributions—with no self-employment tax on that portion. That tax saving can justify the added cost of payroll setup and quarterly filings.

Key Considerations Before Electing S‑Corp

Transitioning requires more than just paperwork. You must:

• Form an LLC or corporation in your state.
  
  
• File Form 2553 with the IRS within 2 ½ months into your tax year to make the S‑Corp election..
  
  
• Adhere to IRS rules: only one class of stock, no more than 100 shareholders (who must be U.S. individuals or certain trusts), and reasonable compensation.
  
  

Ongoing costs include payroll management, annual filings and meetings, and occasional corporate formalities—not to mention possible state tax implications (e.g., New York state requires a separate S‑Corp election) .

LLC vs. S‑Corp: Choosing the Structure That Fits

While both LLCs and S‑Corps offer liability protection and pass-through taxation, the experience of running each structure—and the benefits they offer—can feel quite different.

A single-member LLC keeps things simple. It offers liability protection without drastically changing how you file taxes. You’ll continue to report income on Schedule C, and you’ll pay self-employment tax (15.3%) on all net profits. This structure is flexible and easy to manage, with minimal paperwork and few formalities. It’s a natural next step for sole proprietors who want personal asset protection without adding too much operational complexity.

An LLC that elects S‑Corp taxation—or a corporation that does the same—comes with more requirements but also more opportunity for tax savings. The key difference is how income is treated. In an S‑Corp, you’re required to pay yourself a “reasonable salary,” which is subject to payroll taxes. But the remaining profits can be taken as distributions, which aren’t subject to self-employment tax. This split can lead to significant tax savings once your net income reaches around $60,000 or more.

However, S‑Corps are more rigid. You’ll need to run payroll, file payroll tax returns, and ensure that profits are distributed strictly according to ownership percentage. You’ll also need to keep corporate records, hold meetings, and file annual reports.

So, how do you decide? If you value simplicity and flexibility and your profit is still relatively modest, a single-member LLC might be the best fit. If your profits are growing and you’re ready for a bit more structure in exchange for tax savings, an S‑Corp election may be worth it.

Either way, the shift from sole proprietorship to a formal business entity is a meaningful milestone—one that signals growth, credibility, and strategic thinking.

Next Steps for Business Owners

1. Evaluate your business risks and profits. If liability exposure is rising or net income exceeds around $40,000, it’s time to explore options.
   
   
2. Consult a tax advisor or attorney—they can help form your LLC or corporation, file S‑Corp election, and set up payroll systems.
   
   
3. Weigh costs vs. benefits. Setup fees, payroll, accounting—with the resulting self-employment tax savings often outweigh these costs.
   
   
4. Stay compliant. Once elected, maintain payroll, distribute profits correctly, and hold any required meetings or filings annually.
   
   

Final Takeaway

Transitioning from a sole proprietorship to an LLC, and potentially electing S‑Corp taxation, is a powerful move that delivers personal liability protection and offers meaningful tax savings. The key is timing: making the switch too early might not justify the added complexity, but waiting too long means missing out on deductible benefits and business credibility.

If your New York–based business is growing, signifying increased risk or profit, let The Holtz Group help you evaluate the best structure, help with formation, and stay compliant every step of the way.