S Corp vs. LLC
LLCs and S corporations are different types of formats of business operations. However, pursuant to tax law, they are not mutually exclusive.
Limited liability companies (LLCs) and S (Subchapter) corporations are often discussed together, but this is a mischaracterization.
What’s different about an LLC vs. an S corp. is that an LLC is a business entity while an S corp. is a tax classification.
The difference between an LLC and S corporation
What Is an LLC?
A limited liability company is a legal designation that can protect small-business owners from personal liability in business obligations. Owners of LLCs are known as members. LLCs can have one owner (single member LLC) or more than one owner (multi-member LLC). Owner-employees of LLCs are self-employed for self employment tax purposes.
LLCs offer a formal business structure, while they can also be taxed similarly to sole proprietorships, corporations or partnerships. An LLC is more flexible than a corporation in organization and profit distribution. An LLC can also choose taxation as a corporation, and owners can save money by electing S corp. tax status. An LLC taxed as a partnership can specially allocated net income among the members in a different ratio than capital ownership.
What Is an S Corp.?
An S corporation is a tax classification is generally designed to protect small-business owners’ assets from double taxation.
An S Corporation may or may not also be a corporation under state law. That’s because a company formed as an LLC under California can elect to be taxed as an S Corporation or a C Corporation.
An S corp. utilizes pass-through taxation, meaning an owner claims a share of company profits on their individual tax return. This ensures profits aren’t double-taxed (once under the corporation and again under the owner).
The “S” in S corp. stands for “subchapter,” because an S corp. is a subchapter corporation in that the provisions for the taxation of S Corporations are found in Subchapter S of the Internal Revenue Code.
When incorporating a business, you’ll first form a C corp. that must meet S corp. requirements to be so classified. The requirements include electing S corp. status two months and fifteen days after officially organizing your business (for the status to affect the current tax year), capping ownership at 100 individuals (not entities or partnerships), and limiting those owner shares to U.S. citizens only. If you form an LLC, you’ll also need to file IRS Form 2553 to elect a tax classification.
S corp. owners can be company employees. Owner-employees must pay themselves a reasonable salary for their work. They’ll pay federal and state income tax, Medicare tax, and Social Security tax on that salary. Owners receive additional profits as distributions, which aren’t subject to Medicare and Social Security taxes.
What’s the Difference Between an S Corp. and an LLC?
As explained above, an S corp. is a tax classification, while an LLC is a business entity. This means that an LLC can attain S corp. status if it meets certain criteria. However, LLCs and S corporations require different management and shareholder structures and have unique reporting requirements.
LLC owners of an LLC taxed as a partnership or sole proprietorship are not characterized as employees.
S corporations can employ their owners and pay them a salary. An LLC that is treated as a corporation can also pay owners a salary. If your LLC makes a profit after paying owners a reasonable salary, you might save money on taxes by electing S corporation taxation.
By default, an LLC operates the same way as a sole proprietorship or partnership. However, an LLC can have unlimited owners (members) from all over the world; these owners can also be another corporate entity.
An S corp. and an LLC that elects to be taxed as an S Corporation must be a U.S. business owned by U.S. citizens and cannot have more than 100 owners. Beyond individuals, S corporations limit ownership to trusts and estates.
A corporation has a board of directors who make high-level, not day to day, decisions about running the business. Shareholders are responsible for electing directors to the board. Officer roles like president, vice president, and treasurer also exist to manage daily business operations outside the responsibilities of the board of directors.
Managers run LLCs rather than directors. Owners can participate in management (a member-managed LLC), or elect to hire managers to take on the responsibility (a manager-managed LLC). An LLC can also choose to appoint officer roles if that structure makes sense within the business plan.
Stock and Shareholders
An S corp. can only issue common stock, which gives voting rights to shareholders. An LLC does not issue stock and does not have shareholders, but rather must pay members according to the LLC’s articles of organization. If you decide to incorporate your LLC with S corp. classification, issue units or percentages, not stock.
Tax Liability and Reporting Requirements
Standard taxation for LLCs mirrors sole proprietorships (for single-member LLCs) and partnerships (for multi-member LLCs). Single- and multi-member LLCs can also elect to be taxed as C corporations or S corporations if they meet eligibility requirements. Non-S corp. LLC owners must pay a 15.3% self-employment tax on all net profits*.
S corporations have looser tax and filing requirements than C corporations. An S corp. is not subject to corporate income tax and all profits pass through the company. A C corp. must pay taxes quarterly in addition to owners paying annual income tax on their share of the profits.
S Corp.: Owner can take a salary and avoid self-employment taxes on the rest of profits
LLC: Owner must pay self-employment tax on all net profits if taxed as a sole proprietorship or partnership
Cost To Establish
The cost of establishing an LLC and electing S corp. Status can vary depending on factors like which state you live in and whether you conduct business across state lines. Legal help will cost extra, but will likely save you money and time while helping you avoid common mistakes.
The average cost of filing articles of incorporation, not including lawyer fees, ranges from $100 to $250* depending on the particular state you file in. Forming an LLC costs between $50 and $500, depending on the state. If you do business in other states as an LLC, you’ll need to register to conduct business in each of those states, which will cost an additional foreign business registration fee.
S Corp.: incorporation fees range from $100 to $250
LLC: formation fees vary from state to state, ranging from $50 to $500
LLC vs. S Corp.: Which Option Is Best For You?
LLCs and S corporations are different aspects of business structure. Choosing to pursue one, both, or neither classification could benefit your business in different ways. Take into consideration your needs when running a business, and ask yourself the following questions to get a better idea of which designation is right for you.
How many owners have a stake in your business?
Are all of your business partners U.S. citizens?
Does a partnership or corporation have a stake in your business?
How would a self-employment tax affect your net profit?
The answers to these questions can help you determine the fit of an LLC designation or S corp—classification for your business. Below, we’ll explore how the potential answers could affect you and your profits.
An S Corp. May Be Best For You If:
S corp. tax classification might be best for your business if you have plans to scale. S corporations require additional tax forms and payroll systems, which might not be worth the hassle if your business breaks even or makes a small profit. With an S corporation, you can also contribute more money to retirement plans and position your business for growth.
Separately, an S corporation might be right for you if your company reaches a consistent level of growth. A 15.3% self employment tax levied on an LLC’s profits is a steep tax liability to pay when revenues begin to tick upward.
An LLC May Be Best For You If:
You may want to establish an LLC if you’re concerned about personal liability but want minimal business upkeep. Legal requirements dictating the structure of an LLC are more lax than upkeep requirements for corporations.
Reporting requirements are generally simpler for an LLC than for a corporation. An LLC can have an unlimited number of owners. Partnerships, corporations, or noncitizens can own or partially own LLCs. The LLC should file an annual or biennial report that gives updates on current members, business locations, and other changes.
Which Is Better for Taxes: an LLC or an S Corp.?
Taxes on S corporations are lower than on non-S corp. LLCs. As an LLC owner, you’ll incur steep self employment taxes on all net earnings from your business, whereas an S corporation classification would allow you to only pay those taxes on the salary you take from your company.
However, itemized deductions could make an LLC a more lucrative choice for tax purposes. LLC owners can receive tax breaks for hiring a spouse or minor dependent and can transfer ownership of company property without incurring additional taxes.
Why Would I Choose an S Corp.?
You might choose an S corp. Classification if your company’s structure enlists many people with the task of running the company. A board of directors provides mandatory oversight for business decisions and can reign in rogue actors or veto decisions that might harm the company.
Should My LLC Be an S Corp.?
If your LLC is growing in profitability or you expect it to soon, you should consider S corp. classification. This allows profits to pass through the corporation into your wallet without incurring a hefty self-employment tax on all net earnings.
Both LLCs and S corporations offer personal liability protection that shields your personal assets. When starting a business, it’s important to think ahead and envision what kind of growth you want to achieve. Your goals and aspirations could determine which business entity and tax classifications are right for you.
What Is a Corporation?
A corporation, also known as a c-corporation, is a type of business structure that exists as a separate entity from its owners, who are called shareholders. The corporation pays its own taxes, can own property or enter a contract as an entity separate from its owners, and is responsible for debts or wrongdoing. Shareholders become owners by acquiring shares of stock in the corporation. They play a very limited role in managing the corporation, and they pay taxes only on the profit distributions they receive from the corporation.
What Is an LLC?
A business structured as an LLC is owned by one or more individuals or groups, known as members. LLCs are not separate from their members in the same way that shareholders are separate from the corporation. The LLC itself doesn’t pay taxes. Members pay taxes on the LLC’s profits on their personal income taxes, a process known as pass-through taxation. LLC members can run the company, although some LLCs choose different management structures.
What Is an S-Corporation?
Another type of corporation, an s-corporation, combines some elements of c-corporations and LLCs. Like c-corporations, an s-corporation is a separate legal entity, and shareholders have limited liability for the business’s debts and other obligations. But shareholders in an s-corporation are responsible for paying taxes on the business’s income in much the same way as members of an LLC.
How Ownership Works in a Corporation and an LLC
The rules for ownership, management, and other operations are spelled out for corporations in a set of bylaws. LLCs use an operating agreement to define responsibilities and rules of operation.
In a corporation, the number of shares of stock determines the percentage of the company a shareholder owns. Let’s say a corporation issues 100 shares of stock and sells each share for $10. A shareholder who invested $250 would own 25 shares of stock or 25 percent of the company. If the corporation distributed annual profits to shareholders, this shareholder would receive 25 percent of the distribution.
LLCs don’t issue stock. The operating agreement details the percentage of ownership and the share of profits (or losses) to which each member is entitled. A member’s share of profits is usually based upon the percentage of ownership, but an LLC can divide up profits in a different way, provided it follows the IRS “Special Allocations” rules.
Ownership Is Unrestricted for Corporations But Not LLCs
Shareholders of c-corporations are free to buy, sell, or transfer their shares to anyone on the open market.
LLC members can invest in the company or sell their investment only according to the rules established in the operating agreement (or the rules set by state law when no operating agreement exists). An LLC’s operating agreement might require members to sell their share back to the other members, or it might give the other members approval rights over any sale or buyer. A few states require LLCs to be dissolved and re-formed when a member leaves.
S-Corporations Restrict Certain Types of Ownership
While c-corporations can issue all their stock to a few individuals or thousands, to individuals or other businesses anywhere in the world, s-corporations can’t have more than 100 shareholders, and their shareholders must be U.S. citizens. Ownership in s-corporations is also limited to individuals, and other business entities such as corporations, LLCs or partnerships can’t own stock in the company.
How Corporations and LLCs Are Managed
In general, corporations must follow detailed state laws concerning management practices. LLCs are subject to fewer government rules about how they are managed.
How Corporations Are Managed
Corporations are required to have a board of directors and officers, such as a president and chief financial officer. The bylaws describe the rights and responsibilities of these executives, and most states require corporations to file their bylaws with the state.
Members of the board of directors are responsible for appointing the officers of the company and for overseeing and evaluating the direction of the business. A board of directors might get very involved if, for example, a corporation’s profits fall or the business records a loss. But it usually won’t participate in decisions like hiring, salaries, choosing vendors, and so on. Those day-to-day decisions are the responsibility of the officers of the company.
Shareholders might be asked to vote on decisions such as appointing new board members, but they typically don’t get involved in the day-to-day management of the company unless they are also officers.
Corporations are required by law to hold annual shareholder meetings and to keep minutes of those meetings. They also must issue annual reports.
How LLCs Are Managed
The equivalent of corporate bylaws for an LLC is called an operating agreement. But unlike corporations, most LLCs are not required to file an operating agreement, although a few states do require LLCs to create one.
LLCs have a lot of flexibility in deciding how the company will be managed. In most states, they need not have a board of directors, company officers, annual meetings, or annual reports. An LLC might be managed by all, or just some of its members; and some LLCs hire an outside manager with no ownership in the company to manage it.
Though only a few states require LLCs to issue annual reports, most require other annual filings in order for the company to retain its LLC status.
How Corporations and LLCs Pay Taxes
The corporation, not the shareholders, pays taxes on the profits the business earns. But shareholders are required to pay taxes on any dividends that are paid to them. Many view this tax rule, known as double taxation, as a disadvantage of the corporate structure. Corporations are also allowed many tax deductions for business expenses that can offset the tax bill.
S-corporations, on the other hand, don’t pay corporate taxes. Profits earned by the business are passed through to the shareholders (as is done with an LLC).
In an LLC, all the business’s profits (and its losses) are also passed through to the members. Single-member LLCs are taxed as sole proprietors; they report and pay taxes on business profits on their personal income tax returns.
LLCs with more than one member can elect to pay taxes as a partnership or a corporation. When taxed as a partnership, LLC members pay taxes on the company’s profits on their personal income tax return, based on their share of ownership.
When an LLC elects to be treated as a corporation for tax purposes, the LLC pays corporate taxes, and members pay taxes on any distributed profits. Members are not required to pay taxes on earnings that are retained, so profits that are re-invested into the company are not taxed.
How LLCs and Corporations Are Formed
LLCs and corporations are both formed by filing a document with the responsible state agency, usually the Secretary of State. Corporations file articles of incorporation and LLCs form articles of organization. (The documents might be called by different names in some states.)
The documents typically cover basic information about the business, such as the name and location of the company, the address of members (in the case of an LLC) or directors and officers (in the case of a corporation), the type of business, and its purpose. Corporations also need to provide the number of shares of stock they intend to issue.
Filing fees for corporations vary by state and sometimes by the number of shares the corporation issues. A business in Arizona might pay as little as $60 to file articles of incorporation, while Texas charges $300.
Fees for filing articles of organization for an LLC typically range from $50 to $100, depending on the state.
Corporations and LLCs are also subject to other annual fees, such as annual report filing fees, franchise fees, and business license fees.
Choosing Between a Corporate and an LLC Structure
Corporations and LLCs each offer the advantage of limiting the owners’ personal liability. The entity that’s right for you will depend on your needs. Here are some factors to consider:
LLCs have fewer formalities and offer more flexibility. In general, LLCs don’t require you to hold meetings or issue annual reports. And they offer a lot of flexibility in managing the company, whereas corporations are required by law to have a specific management structure, hold meetings, and observe other formalities.
Tax compliance is usually simpler under an LLC. LLCs don’t pay taxes unless the members elect to be taxed as corporations. Most members pay taxes on the business profits on their personal income tax filing. Corporations are subject to double taxation because the corporation is taxed on earnings, and shareholders pay taxes on the profit distributions they receive.
It’s easier to attract investors as a corporation. Investors prefer corporations because they can buy into the business or sell their stock on the open market, without restrictions. Buying into or selling ownership in an LLC usually requires the approval of the other members, and other requirements might apply. S-corporations also have ownership requirements that make them less advantageous for investors.
Corporations have more options for providing employee benefits. Corporations can offer benefit plans like stock options that most LLCs can’t. Tax deductions for many benefit plan expenses are also available to corporations, whereas LLCs can usually deduct only a portion of the expense of any benefits they offer.