This question came up twice this last week so I thought that I would dump my logic and see what people may correct me on… First, the difference between a LLC and proprietorships is simple – with a LLC, you are not personally liable; so a LLC is definitely preferred. For a S-Corp versus a C-Corp, the difference is that with a C-Corp you may have double taxation.
Bottom line is a LLC (which may be a proprietorship) and a S-Corp. For a short summary see here
The argument is often to go with an S-Corporation because you can take the money out as distributions and avoid employment taxes. This is true if the reasonable salary for your skill set is below the magic ceiling of $106,800. If you are a software consultant – forget it – the first time that the IRS does an audit, your lower reasonable salary will be laughed at and you will be hit by back taxes, penalty and interest! At $106,800 you have no more employment tax. The rest is subject to a 2.9% Medicare tax.
So there is no savings from employment taxes – and what is the relative cost of a LLC versus a S corporation. Well with S Corp you have a lot more paper work, may have state filing costs every year etc. to quote the link above: “if you form an S-corp, know that you're going to be spending a great many more billable hours with your accountant/attorney.”
So if you gross, $200,000/year – you would pay 2.9% x 94,000= $2726 for medicare versus the legal fees, accounting fees and filing costs of a S-Corp PLUS the time to do the paperwork (which could be billable hours!). See this nice table for reference.
On the flip side, what if you need to hire someone to help a bit? Well, I would run them through RentACoder.com with a clean specification and fix price per quantity of work. There is no risk of them being deemed an employee and if they suck – the folks at rentacoder will mediate and resolve the issue (usually in your favor if you done a good clean specification and criteria).
When I started up, the wife had managed a S-Corp for many years and frankly, did not want the paperwork and filing hassles that came with it. We worked out that a S Corp was actually going to be a wash for $$$ (ignoring time consumed) or actually cost us money! So beware of the sell-jobs that accountants may make for an S-Corp, remember they make money from burdening you with paperwork!