Whats the difference between an llc and an s corporation

Make the best business choice for your company today with our handy guide comparing LLCs and S Corps.

Are you unsure whether to select an LLC or S Corp for your business? Choosing the right business structure for your company is crucial. Here, we explore whether an S Corp or LLC is a better fit for you.

As you will see, this is not necessarily about choosing one over the other because an LLC is a legal business entity while an S Corp is a tax classification that some small businesses may choose to benefit from. As such, it’s important to know how these two business categories can be used to save you money, time and hassle.

Whether you ultimately choose an LLC or S Corp, the following primer will help you make the right choice for your business.

What Is an LLC?

An LLC, or Limited Liability Company, is a legal entity that shields its business owners (or “members”) from personal liability in case the company gets sued. Simply put, the personal assets of an LLC member cannot be used to satisfy any claim against the LLC.

Not only does this liability protection appeal to business owners but LLCs are also simple to form and relatively flexible to manage. There are a handful of business formation services that can help you incorporate your LLC. In sum, LLCs can be considered as a useful cross between a partnership and a corporation.

What Is an S Corp?

As mentioned, an S Corp is essentially a tax classification rather than a legal business structure. It allows the IRS to tax you as a partnership and precludes the IRS from corporate-level, double taxation. Specifically, in a corporation (unlike an S Corp), the profits are taxed on the corporate level and then the dividends are taxed personally for each shareholder.

Unlike common C Corps, an S Corp does not pay corporate income tax, but the tax profits and liabilities pass through to the business members’ personal tax returns. To opt for S Corp status for your taxes, your company must:

• Be a US business so that you file with the IRS as such
• Not have more than 100 business owners (aka “shareholders”)
• Have all shareholders as either individuals, trust or estates
• Have one class of stock

S Corp taxation benefits LLC members inasmuch as they can be taxed as company employees (provided that their salary is reasonable) rather than owners, which can offset the taxable amount due every year.

How and When Should I Structure an LLC as an S Corp?

You must file an S Corp Election Form 2553, with the IRS if your LLC elects to become an S Corp. This must be filed two and a half months after the beginning of the relevant tax year that you want the S Corp status to take effect.

When an LLC turns a profit that is sizable enough to warrant tax considerations, it might be time to contemplate filing for S Corp status. This way, an LLC could preclude further dealing with state law requirements on matters of assigning officers and directors as well as having board meetings.

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LLC or S Corp? Similarities and Differences

Taxation and Fees

Taxation of LLCs and S Corps differs in part because an LLC is governed by state law while an S Corp is regulated by federal law. An LLC is taxed as a sole proprietorship or, in the case or multiple shareholders, a partnership. An LLC must pay self-employment taxes (including Social Security and Medicare taxes) to the IRS and any income gained by the LLC is deemed taxable. As such, the taxable amount passes through to the owner’s personal taxes at the owner’s individual tax rate.

In contrast, with an S Corp tax election, the company pays payroll taxes to its shareholders who then pay employment taxes. These payroll taxes can also be deducted as a business expense of the company.

Note that the salaries must be reasonable as this is scrutinized by the IRS rather strictly. Also, when the business has profits, they can be given to the shareholders as dividends and those dividends can be taxed at a lower taxable rate than standard income. Expect your accounting fees to increase as a result of this more financially complex S Corp election and the IRS’s reasonable compensation requirement.

Ownership, Management and Shareholder Structure

An LLC is more flexible than an S Corp as to who can be an owner. Also, an LLC does not restrict the number of owners, while an S Corp’s maximum is bounded at 100 who, unlike in an LLC, must all be US citizens.

Furthermore, while there are no limitations on the types of stock that members can have with an LLC, only a single class of stock is allowed with an S Corp. In light of these S Corp restrictions, an LLC may be the preferred option for companies that are requiring such freedoms.

Solopreneur Considerations

Is an LLC or S Corp Better for Entrepreneurs?

A startup in the initial phases might benefit from being an LLC; however, when your company begins to amass profits, it might be better off as an S Corp given the tax benefits.

Can a Single-Member LLC be an S Corp?

S Corps make financial sense to many LLCs, but for single-member LLCs – unless there is a clear and viable reason to be taxed as an S Corp – it may not be the best route. Also, given the IRS’s reasonable compensation requirement for business owners with S Corps, single-member LLCs might feel more restricted.

Still Trying to Decide Whether an LLC of an S Corp is Best for You?

If you’re concerned about the LLC formation process, there are resources available. Find out how easy, and affordable, it can be to form your LLC online today.

Legal Disclaimer: This article contains general legal information but does not constitute professional legal advice for your particular situation and should not be interpreted as creating an attorney-client relationship. If you have legal questions, you should seek the advice of an attorney licensed in your jurisdiction.