S Corp VS LLC: What is the Difference?

When starting a business, you’ve many decisions; one is choosing a structure.
An LLC is a common choice because it offers many benefits to small business owners. The only problem is the more you earn, the more tax you`ll pay!
Another option is becoming an S corp; LLC owners often do this because of the tax savings.
An LLC and an S corp have important similarities, such as liability protection and pass-through taxation. But they also have significant differences that affect how much tax you`ll pay and how you pay it.
So, S corp vs. LLC, what is the difference?
Let’s find out so you can choose the best structure for your business.

What is an S Corporation?

An S corporation is a tax classification, not one of the many available business entities. And before you can become an S corp, you must first create an LLC or C corporation.

S corporations (and LLCs) are “pass-through entities,” and all profits pass through to the shareholder’s/owner`s tax return, avoiding corporation tax and double taxation.

LLC business owners whose income is higher than the industry average can elect S corp taxation to reduce their self-employment tax bill. You take a reasonable compensation (an average industry salary) and any remaining profits as distributions not subject to self-employment tax.

What is an LLC?

An LLC is a legal business structure that provides liability protection to its owners, protecting their assets in cases of debt or litigation. 

There are types of LLCs. Two of the main ones are:

• Single-member LLC with one owner that pays tax like a sole proprietor.
• Multi-member LLC with more than one owner that pays tax similar to partnerships, unless either applies to pay tax as an S corporation.

LLCs are popular because they’re easy to start and run, and you gain liability protection plus certain tax benefits. However, earning over $80,000 yearly could mean a hefty tax bill.

You can lighten your LLC tax load by applying for S corp taxation, which changes how you pay taxes on specific parts of your business income. 

To start an LLC, you must file an article of organization with your secretary of state’s office. Then file Form 2553 to elect your tax classification with the IRS.

After approval and when your LLC meets specific IRS criteria, you can elect for S corp taxation.

What are the main differences?

Business entities cause much confusion among aspiring business owners, so let’s cut to the chase and look at the main differences between an S corp versus LLC:

• A Limited Liability Company (or LLC) is a legal business structure that separates your business and personal assets, protecting you from liabilities.
• An S Corporation (or S corp) isn’t a legal structure but a tax election that provides limited liability protection and determines how your business pays taxes at state and federal levels.
• LLCs and S corps also require different shareholder and management structures with particular tax and annual reporting requirements. We’ll look at those differences next.

1. Ownership

There aren’t any IRS rules restricting LLC ownership, but there are with an S corporation; they include:

Key differences:

• An LLC can have unlimited members, while an S corps can only have 100 shareholders (owners) or fewer.
• LLC members can be non-US citizens/residents. An S corps shareholders/owners must be US citizens or US-based estates or trusts.
• Individuals, partnerships, or other corporate entities can own an LLC. An S corps ownership is limited to individuals, estates, and trusts.
• LLCs can have unrestricted subsidiaries.

2. Management

Management structure refers to who runs a business and how they implement high-level and daily decisions. 

You can choose one of two management structures for an LLC:

• Owners can run their business (member-managed)
• Or they can hire external managers (manager-managed LLC)

Manager-managed LLCs resemble an S corporation, as owners (members) do not participate in daily business decisions. 

In contrast, S corporations have a board of directors that the shareholders (owners) elect. The directors handle critical decision-making and hire officers to run the business. Shareholders do not manage or take part in daily operations.

Key differences:

• LLC managers (owners) can choose to run daily business operations or appoint managers.
• An S corporation’s shareholders must elect a board of directors who appoint officers to run daily operations.

3. Self-employment taxes

Single-member LLCs file and pay taxes like sole proprietors, and multi-member LLCs as partnerships. Both pay a 15.3% self-employment tax on all net profits.  

To reduce their self-employment tax bill, single and multi-member LLCs can elect for S corp taxation if they meet IRS eligibility requirements.

S corp shareholders can work as employees and receive a salary (adequate compensation) for their service. 

Wages are also subject to payroll taxes, at 15.3%, but the S corp pays 7.65% and employees the other 7.65%. Shareholders can then receive further payments as (distributions) which aren’t subject to payroll taxes.

Key differences:

• LLC owners must pay a 15.3% self-employment tax on all net profits.
• S corp shareholders can work as employees, pay 50% FICA tax, and receive extra (self-employment tax-free) distribution payments.

4. Allocation of profits and losses

LLC owners can split business profits and losses between members as they choose. For example, a multi-member LLC owner with a 50% interest could receive 70% of all profits and losses. 

In contrast, S corp shareholders receive profits and losses relative to their percentage ownership.

5. Stock and shareholders

LLCs cannot issue stocks, and there are no shareholders; instead, members receive payments relative to an LLC’s articles of organization. 

An S corp can issue “common stocks” (shares of the business), giving shareholders voting right relative to their stock percentage ownership.

Key differences:

• LLCs do not issue stocks; they pay members a percentage wage plus distributions.
• S Corporations can issue common stocks to shareholders, pay them as employees, and make tax-free distributions or dividends.

6. Business Operations

LLC business operations are more straightforward and have fewer requirements than other corporate structures.

Sure, the IRS and accountants advise LLCs to follow bylaws and corporate guidelines, such as conducting annual meetings and maintaining meeting minutes, but it’s not a legal requirement.

Key differences:

• LLCs only require a flexible operating agreement written by their members. And file annual reports to maintain “good standing” with their state.
• S corporations are more rigidly structured and must adhere to various legal requirements, including adopting corporate bylaws (a legal document outlining an S corporation’s rules and regulations governing its daily operations), holding annual meetings, maintaining meeting minutes, and issuing stocks and shares.

7. Transferability of ownership

There are no restrictions regarding transferring the S corp stock to another person. Shareholders do not require their owners’ permission but may have tax matters to address on profits or losses and must adhere to the IRS ownership restrictions. 

In contrast, LLC ownership (member’s interest) isn’t freely transferable, as owners need approval from all other members.

The similarities between S corps and LLCs

1. Limited liability protection

The LLC entity and the S corp tax election provide limited liability protection to their members and shareholders and are solely responsible for any business liabilities and debts. Except in cases where owners/members/shareholders are found guilty of piercing the corporate veil.

2. Separate entities

LLCs and S corporations are separate legal entities from their owners, who create them by filing with their state of business. 

That said, LLCs and S corp formation requirements differ and are governed by different statutes (laws and rules) as per their location.

3. Pass-through taxation

S corporations and LLCs are pass-through/flow-through tax entities. All profits and losses pass through to the members/shareholders, who report them on their tax returns, avoiding corporation tax and double taxation.

S Corp Vs. LLC Pros and Cons

Choosing between an S Corp VS LLC is a significant decision for business owners. 

You now know they have many similarities and essential differences. And if you form an LLC and don’t elect an S corp tax designation, you could miss out on substantial tax savings. 

But if it were that straightforward, every entrepreneur would apply for S-corporation tax status. 

As always, there are pros and cons you should consider and benefits to each structure that often influence your decision. Here are the essential pros and cons between S Corp Vs. LLC.

S corp pros:

Reasonable compensation

• S corp owners can receive a wage “reasonable compensation” as an employee. Wages are subject to payroll taxes (FICA); the S corp pays 50%, and the owners pay the remaining half.

Dividends

• S Corp offers tax savings on profits above your “reasonable compensation.” These profits aren’t subject to payroll or self-employment tax. Tax-free employee dividends are also an excellent incentive for highly qualified people to choose your business, helping you attract the best talent.

Pass-through taxation

• S corporations don’t pay corporate taxes, avoiding double taxation. Instead, all profits and losses pass through to the owners, who report them on their tax returns.

Qualified Business Income Deduction

• S Corp owners can be eligible for the QBID 20% pass-through deduction, allowing you to deduct 20% of your business profits from your income taxes.

Credibility

• An S corporation can bring credibility to your business, improving relations and building trust with investors, suppliers, and clients.

Limited liability protection

• S corps, like LLCs, are separate entities to their owners that provide a shield of liability protection, securing your assets in business debt or litigation cases.

Funding

• S corporations have more options to raise funds than LLCs, such as venture capitalists who invest in exchange for shares in your business.

S corp cons:

More cumbersome to start and run

• S corps can take more effort to start and run than an LLC. Shareholders must elect a board of directors who must select officers to control daily operations. And adhere to stricter guidelines, such as annual meetings and maintaining records, annual reporting, and issuing stocks.

Less control

• S corp shareholders have less control over their business than LLC members as the board of directors and elected officers control business operations.

Not recognized in all states

• Not all states allow an S corps income to pass through to the shareholders, instead taxing the business like a C corp, which means paying double taxation. Your local Secretary of State office will tell you more.

LLC pros:

Limited liability protection

• Like an S corp, single and multi-member LLCs are separate legal entities to their owners. Limited liability protects the owner’s assets from lawsuits and business debts, and creditors can only seek assets belonging to the business.

Easier to start and run

• LLCs are easier to start and operate compared to an S corporation. To create an S corp, you must first register a business entity like an LLC or C corporation and then apply for S corp tax election.

Pass-through taxation

• An LLC passes its profits and losses to the owners, who report them on their tax returns, avoiding corporation tax.

Flexible structure

• LLCs have a flexible structure, which is popular with small business owners. For instance, there are no limits on the number of owners; members can be non-US citizens/residents, and you can run an LLC as a member-manged (an owner acts as manager) or a manager-managed business where you employ an external manager to care for daily duties.

LLC Cons:

Investment options

• An LLC’s primary disadvantage is a lack of funding options. Most LLCs can only get funding from banks (or family and friends). Other lending institutions, like venture capitalists, only fund corporations where they receive shares.

Operational fees

• LLCs have unavoidable start-up and operational fees, including the costs of filing articles of operation, annual reports, and, most times, employing a registered agent.
• Some states also charge LLCs an annual franchise tax, allowing them to operate in their location, which can cost between $50 to $800, depending on the state.

How to choose a structure that is right for you

Many small business owners don’t begin with an S corp; instead, they transition organically as their business grows from a sole proprietorship/partnership to an LLC. And when their income warrants the tax savings, an S corp. 

However, changing your business structure can incur tax penalties and involve extra fees. Choose one you can stick to before registering an entity. 

But how do you know which structure is right for you? If that question sounds familiar, trust me, you’re not the first entrepreneur to ask it!

Here is a quick recap to help you decide:

To choose a structure suitable for your business, evaluate your market’s opportunities and possibilities, whether you’ll need staff to take advantage of them, and the tax considerations each structure provides. 

And remember, while complex business structures like S and C corporations allow for tax minimization, they also cost more to start and maintain.

• LLC-Suits entrepreneurs starting a business on a smaller budget who need liability protection, aren’t looking for venture capitalist investment, and want to keep control of their business.
• S corp-Suits business owners who need liability protection want to reduce their tax bills, attract outside investment, and sell common stocks.

Conclusion

Forming an LLC structure is the next logical step for many general partnerships and sole proprietors. It formalizes their business and provides limited liability, protecting their assets from litigation and debt. 

But there are cases when starting a business that an LLC isn`t the right choice; that`s when an S corp comes into play.

Your structure choice depends on your funding needs, business income, and future goals. 

And as you need to form an LLC to get S corp designation, it’s a safe decision. 

Hi, I’m a business and marketing writer living the digital nomad lifestyle between Spain and Italy for over three years now. 

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