When opening up a new business or setting up an online store, you’re faced with the question of whether an LLC or S-corp is the right legal formation for you and your needs.
These two business models can make a significant difference in how you run your company from legal, tax purposes and management perspectives. Here’s what you need to know.
Summary
What is an LLC?
A limited liability company (LLC) is a legal entity formed at the state level. An LLC exists separately from its owners—known as members. However, members are not personally responsible for business debts and liabilities. Instead, the LLC is responsible.
The possibilities for how to structure an LLC are almost endless, which can be a blessing and a curse. This makes interfacing with an LLC challenging, because one has to examine the operating agreement (and potentially other contracts signed between the members) to get a handle on how the company is governed.
Corporations, by comparison, are more standardized: They share commonalities like stock to represent ownership, are governed by a board of directors, have day-to-day operations handled by officers.
What is an S-corp?
An S corporation is a regular corporation that has elected “S corporation” tax status. Forming an S corporation lets you enjoy the limited liability of a corporate shareholder but pay income taxes as if you were a sole proprietor or a partner in a partnership.
In a regular corporation (also known as a C corporation), the company itself is taxed on business profits. The owners pay individual income tax only on money they receive from the corporation as salary, bonuses, or dividends.
In an S corporation, all business profits “pass through” to the owners, who report them on their personal tax returns (as in sole proprietorships, partnerships, and LLCs).
The S corporation itself does not pay any income tax, although an S corporation with more than one owner must file an informational tax return, like a partnership or LLC, to report each shareholder’s portion of the corporate income.
LLC and S-Corp Comparison Chart
When starting a business, LLCs and S corporations are two terms that are often discussed side-by-side, they actually refer to different aspects of a business. An LLC is a type of business entity, while an S corporation is a tax classification.
An S corporation election lets the Internal Revenue Service (IRS) know that your business should be taxed as a partnership and to become an S corporation, your business first must register as a C corporation or an LLC and meet specific guidelines set by the Internal Revenue Service (IRS) in order to qualify.
| LLC | S-corp | |
| Qualifications | No restrictions when forming LLC | 100 shareholders max |
| Can be owned by individuals, corps or foreigners | Owners must be US citizens/green card holders or have filed personal US tax returns for last 2 yr | |
| No more than 25% passive income (income from rents/investments) | ||
| Only have 1 class of stock | ||
| Liability | Limited to amount invested | Limited to amount invested |
| Federal Tax Treatment | Pass through entity | Pass through entity. |
| Members pay taxes | Taxed once on shareholders | |
| No LLC tax return | No corporate level taxation. Still file corp tax return | |
| Self Employment Tax | Assessed on 100% of the profits if a single member LLC | Minimized by paying reasonable salary and taking dividends |
| Share of Profits & Losses | Share of profits/losses can be set by operating agreement & later by other agreement | Shareholders receive percentage of profits & losses based on percentage of shares owned |
| Record keeping | Board and shareholder annual minutes not required but recommended | Board annual minutes as well as shareholder annual minutes required |
| Annual report (fee typically $250) | Annual report (fee typically $100) | |
| Recommended for | If holding real estate or long term investments | Best tax and liability protection |
| If varying income distributions from year to year | If you qualify then this is typically the best bet | |
| Items needed or recommended | Indemnification Agreement | Indemnification Agreement |
| Operating Agreement | Shareholder Agreement | |
| EIN | EIN | |
| County Recording | Business Registration | |
| Corporate Counsel | New Hire Reporting Forms | |
| Unemployment Report | ||
| County Recording | ||
| Corporate Counsel |
Pros and Cons
Now that you know the differences between an LLC and an S-corporation, it’s time to see how those differences apply to your business and make a decision.
A business attorney or tax professional is the best-qualified person to go through your the benefits of an LLC as well as your books and financial statements and determine what’s in your business’s best interest.
That said, here are general things to keep in mind when choosing an LLC vs. S-corporation:
Advantages
| LLC Advantages | S-corp Advantages |
| Flexibility to choose how you’re taxed (avoid double taxation) | Don’t pay federal taxes at the corp level |
| Pay lower annual fees | Can offer cash payments via dividends to incentivize employees and attract talent |
| Fewer governance requirements | Allow the owner to benefit from personal liability protection |
Disadvantages
| LLC Disadvantages | S-corp Disadvantages |
| More difficult to raise money from investors | Some states don’t allow an S-corp to be taxed on the owner’s personal tax returns |
| S-corps can be slower to establish as a board of directors and corporate officers are required |
LLC vs S-corp taxation and liability protection
One of the main similarities between S corporations and LLCs is limited liability protection; both entities protect owners from the debts and liabilities of their businesses.
Both LLCs and S-corps are separate entities from their owners that are created by filing with the state. Both must file annual reports and pay fees for continued authorization to do business in their states.
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