It's dirt cheap to run your business as a sole proprietorship. There's no filing fees, no minimum taxes, no paperwork, other than the city business taxes and the like that every business must pay. And you get the deductions for business use of home, business expenses, etc.
But despite these savings, running a sole prop comes with one huge risk: You are personally guaranteeing every obligation your business enters into. If your business signs a lease for a store front and you wind up breaching the lease, the landlord is entitled to the remaining rent on the lease at the time of breach. If that's $100,000 and you have that much in equity in your home, guess where that's going to come from?
Limited liability entities
Yup, you just lost all the equity in your house, if not the house itself, or you've been forced into bankruptcy. Viewed from that perspective the $800 minimum tax bill for an LLC or S corporation is pretty freaking cheap.
When your LLC or S corp enters into that store front lease, the landlord is left trying to get the money out of the business entity -- not you personally. If your breached the lease because your business is bust and the company has no assets, the landlord will get a judgment against the company but won't be able to collect from you.
OK, that sounds better!
The LLC is quite flexible and friendly entity. In California there can be single-member LLCs as well as several member LLCs. There are member-managed LLCs (most common in smaller companies) and manager-managed. The key benefits of an LLC: fewer rules in terms of formalities like boards, meetings; and greater flexibility. In an LLC the members can allocate profits however they like, however seems fair. For instance, if one person is going to put in all the work and someone else the money, they might want to structure the profits in a particular way. You can do that with an LLC.
The S Corp and the employment tax
If you're self-employed, you have a special relationship with the alluring Form SE. Yup, the self-employment tax: 15.3 percent of net income goes straight to Uncle Sam and despite the thousands you have in deductions for home mortgage interest, SEP-IRA contributions, HSA contributions, you can't get away from that tax. An LLC doesn't solve that problem.
But an S corporation does. As a corporate employee, you pay yourself a salary and you pay self employment taxes on just that amount. You can take more money as a distribution, and you don't have to pay taxes on the distribution amount.
Thus you can save thousands a year in taxes by paying yourself a reasonable salary - but it must be reasonable - and taking the remainder as a distribution. If taxes are a concern, the S corp may be an attractive way to go. But there are many more restrictions on S corps, so seek a business lawyer's counsel to make sure the trade off is worth it.