Chapter 1 · LLC vs Sole Prop vs S-Corp
The first legal decision: how to structure the business. Plain-English explanation of the three common options and which fits a single-owner claw shop.
Learning objectives
- Understand the difference between a sole proprietorship, an LLC, and an S-corp.
- Know the liability protection each offers (and doesn't).
- Pick the structure that fits a small claw machine shop.
Why structure matters at all
Your "business structure" is just who the business legally is and who's responsible if something goes wrong. It affects your taxes and, most importantly, whether your personal money is protected if the business is sued or can't pay its debts.
The three options
1 · Sole proprietorship (simplest, least protection)
You are the business. There's no separate legal entity — you just start operating and report the income on your personal tax return. There's essentially no paperwork to "form" it, but you are personally liable for everything: debts, lawsuits, injuries at the shop. If someone sues the business, they can come after your house, car, and savings.
2 · LLC (Limited Liability Company) — the usual choice
An LLC is a separate legal entity that you own. The big benefit is liability protection: the business's debts and lawsuits are generally the business's problem, not yours personally (as long as you keep business and personal money separate — more on that in Vol 6). It's the default, sensible choice for a small shop with one owner.
- Formation: file Articles of Organization with your state; costs ~$50–$300 depending on state.
- Taxes: by default a single-member LLC is a "disregarded entity" — you report business income on your personal tax return (Schedule C). Simple.
- Optional S-corp election: an LLC can elect to be taxed as an S-corp (see below) later, when profits justify it.
3 · S-corporation (S-corp)
An S-corp is a tax status — the business is an existing corporation or LLC that elected to be taxed as an S-corp. The advantage: you can pay yourself a "reasonable salary" (subject to payroll taxes) and take the rest as distributions that avoid self-employment tax (the ~15.3% Medicare/Social Security tax on self-employment income). This can save money once profits are meaningful — but it adds payroll administration, a separate tax return, and complexity.
For a small claw shop just starting, an S-corp election is usually not worth it until your net profit is comfortably above ~$40k–$60k/year. Until then, the extra payroll and filing costs outweigh the self-employment-tax savings. Start as a plain LLC; revisit the S-corp election once the numbers justify it.
Side-by-side
| Factor | Sole prop | LLC | S-corp (via LLC) |
|---|---|---|---|
| Paperwork to form | None | One filing with the state | Same + federal election |
| Protects your personal assets | ❌ No | ✅ Yes | ✅ Yes |
| Simplest taxes | ✅ Yes | ✅ Yes | ⚠️ More complex (payroll) |
| Best fit for | Side gigs, tiny risk | Most small shops | Higher-profit businesses |
| Typical annual state cost | None extra | ~$0–$800 (varies) | Same + filing fees |
An arcade has people, machines, and minor injuries. Form an LLC. The cost is small and the protection of your personal assets is worth it. A lawsuit over a child hurt near a machine would otherwise threaten everything you own. (Insurance is Chapter 4 — do both.)
Recommendation for your claw shop
- Form a single-member LLC. It's the right balance of protection, simplicity, and cost for a small shop.
- Keep business and personal money completely separate (separate bank account, separate card) — this is what preserves your liability protection.
- Revisit S-corp election only once net profit stays comfortably above roughly $60k–$70k/year — that's around where the payroll complexity becomes worth the self-employment-tax savings. Don't elect it on day one.
- Check your state — LLC filing fees run ~$35–$500, plus annual fees that vary wildly (California has a notable $800/year minimum franchise tax; many states are just $50–$100 + a small annual report). Your state's Secretary of State website lists the exact numbers.
Plan on $50–$600 one-time to form the LLC (state filing + any registered agent), plus $0–$1,200/year ongoing depending on your state (California is the high end). The EIN from the IRS is free. Full budget is in Vol 1 · ch 4.
Summary
A sole proprietorship is easiest but leaves your personal assets exposed. An LLC protects you while staying simple and inexpensive — the right default. An S-corp election saves self-employment tax but only pays off at higher profit and adds complexity. For a new claw shop: single-member LLC.
Checklist
- ☐ Decided to form a single-member LLC.
- ☐ Looked up your state's LLC filing fee and annual requirements on the Secretary of State website.
- ☐ Plan to open a separate business bank account (Vol 6 covers this).
Looking ahead
With your structure chosen, Chapter 2 walks through the concrete steps to actually form it and get your tax ID.