For a sole proprietorship, reaching an annual turnover of 5 million is a delicate tipping point. Many people’s first reaction is, ”Convert to a limited liability company—the corporate income tax rate is only 25%, which is lower than the 35% rate for sole proprietorships.” But the decision to convert shouldn’t be based solely on tax rates—getting this step wrong could result in paying an extra tax or missing a potential pitfall.

I. First, Let’s Examine the Tax Burden Logic for the Two Types of Entities

II. Why ”Don’t Just Look at the Tax Rate”

The highest tax rate for sole proprietorships is 35%, while the corporate income tax rate for limited liability companies is 25%—on the surface, the corporate rate appears lower. However, sole proprietorships are not subject to corporate income tax or dividend tax, and in many regions, they are taxed under a fixed-rate assessment system, resulting in an effective tax rate that is often as low as 1%–3%. When you compare the two after factoring in both taxes, a limited liability company actually ends up with less take-home pay.

In addition to tax rates, there are four other things to consider:

- Responsibility: A sole proprietor isUnlimited liability, business debts can affect personal and family assets; a limited liability company islimited liability, limited to the amount of the capital contribution. · Admission: Many platforms explicitly require this for onboarding, bidding, partnerships with brands, and eligibility to issue special invoices.Limited Liability Companies and even general taxpayers。· Funding: Limited liability companies can raise equity capital and have easier access to loans; sole proprietorships can generally only secure loans through collateral. · Exit: Limited liability companies can transfer shares or exit at a premium; sole proprietorships can only be dissolved and liquidated.

III. The “Accounting Bomb”: Who Ends Up with More When Profits Are the Same?

Assuming annual revenue of 5 million and a profit margin of approximately 20% (annual profit of 1 million):

For the same profit, a limited liability company takes home less than a sole proprietor. 120,000–380,000.”The idea that ”converting to a corporate structure lowers taxes' is an illusion."

IV. The 3 Most Common Pitfalls

- Looking Only at Nominal Tax Rates: I forgot that limited liability companies also have to deal with the 20% dividend tax. · Excluding business licensing requirements: Only when I wanted to take on large orders from the platform or bid on projects did I realize that my sole proprietorship didn’t meet the eligibility requirements. · Disregarding Unlimited Liability: Once a business has high cash flow, significant assets, and employees, the unlimited liability of a sole proprietorship becomes a real risk.

V. A 4-Step Approach: How to Decide Whether to Switch

① View Liability Exposure: Large asset base, significant external debt, and employees → Tend to opt for a limited liability company to isolate risks. ② Check the admission requirements: Determine what type of entity the target customers/platform require, and align on that before making a decision. ③ Net take-home pay: Take into account tax assessments, dividend distributions, and corporate taxes—not just the nominal tax rate. ④ Compliance Conversion: Settle tax obligations, deregister your sole proprietorship, establish a new company, and ensure a seamless transition for social security and tax forms—don’t leave any gaps.

Remember this: Whether or not to proceed depends on responsibility, eligibility, and take-home pay—not on the nominal tax rate.