April 23, 2024
LLC vs. S Corporation: What Are the Differences?

by Denis Kleinfeld

Many business people struggle to choose between a Limited Liability Company (LLC) and an S Corporation (S Corp). Both offer limited liability and a way to avoid double taxation. Yet, they differ in how they are taxed and owned. This can affect your business’s finances and legal standing.

This guide will show you the main ways that LLCs and S corporations differ. We’ll talk about forming them and who can own them. This will help you see which one is a better fit for your business’s structure and goals.

Key Takeaways:

  • Both LLCs and S Corporations protect your personal assets and use pass-through taxation.
  • LLCs let anyone own a part of the business. S Corps restrict who can be a shareholder.
  • LLCs can be run by their owners or by hired managers. S Corps have to have directors and officers.
  • S Corporations have more rules and paperwork to handle than LLCs.
  • Your decision between an LLC and S Corp should match what you want to do with your business.

LLCs and S Corps: Similarities and Differences

Many business owners look at two common choices: LLCs and S corporations. They both shield personal assets, create a legal boundary, and pass profits or losses to owners for taxes. But they differ in who can own them, how they’re run, and what they must do to keep it legal.

Similarities

Both LLCs and S corps keep the business’s troubles away from the owners’ personal stuff. So, if the business owes money or has legal problems, the owners’ savings and properties are usually safe. The most they can lose is what they put in the business.

Also, these types of businesses are seen as separate from their owners. They are made by following state laws for either LLCs or Subchapter S corporations for S corps. This gives them powers, like sue or be sued, and rules to follow under state law.

Furthermore, they both let business profits or losses go to the individual owners for tax-paying, rather than the business itself paying tax. This setup can be an advantage to business owners.

Differences

But, they’re not exactly alike. The differences are where one might fit a business owner better than the other.

Ownership Differences: In an LLC, anyone can be an owner, with no limits on how many there can be. S corps, on the other hand, cannot have more than 100 shareholders. Only U.S. citizens or residents can own shares in an S corp.

Management Differences: LLCs give owners several ways to run the business. They can choose to manage it themselves or pick managers to do it for them. In S corps, there have to be directors to look after big decisions and officers to handle the everyday work.

Formality Differences: The way LLCs and S corps operate can look pretty different. S corps might need to follow more rules, like having certain kinds of meetings and keeping a record of what’s decided during those meetings. LLCs are also advised to set up their own rules in an operating agreement but don’t face as many state-level obligations.

It can be useful to know these points about LLCs and S corps. Let’s check out a table to compare them in more detail.

LLC S Corp
No restrictions on ownership Limited to 100 shareholders, U.S. citizens/residents
Member/manager management Director/officer management
Fewer formalities Extensive formalities (bylaws, stock issuance, meetings)

Ownership Differences: LLCs vs. S Corps

LLCs and S corporations differ in how they let people own them. It’s key to know the various ways these entities handle ownership.

Ownership Restrictions

One key difference is in the rules about who can own part of the company. LLCs let anyone own part without restrictions, but S corps only allow certain people to own shares.

S corporations can have no more than 100 shareholders. Also, they must be either U.S. citizens or residents. This helps keep the business in domestic hands.

Non-U.S. Citizens/Residents

If you’re not from the U.S., owning shares in an S corporation is tough. S corps only accept shareholders who meet U.S. citizenship or residency rules.

Ownership by Corporations

LLCs can be fully or partly owned by other companies. But S corporations can’t be owned by corporations. This rule highlights how different the ownership rules are for each type.

Ownership by Subsidiaries

LLCs have an upper hand. They can own other companies without limits. This freedom supports business growth and new opportunities.

Classes of Stock

Class divisions for stock is another area where S corps and LLCs differ. S corporations can’t issue various stock types. However, LLCs can design their stock classes as they wish.

Ownership Characteristics LLCs S Corps
Ownership Restrictions No restrictions Limit of 100 shareholders; U.S. citizenship/residency requirements
Non-U.S. Citizens/Residents No limitations Non-U.S. citizens and residents cannot be shareholders
Ownership by Corporations Allowed Prohibited
Ownership by Subsidiaries Allowed N/A
Classes of Stock No restrictions Cannot issue different classes of stock

It’s vital to grasp how LLCs and S corps handle ownership. This knowledge helps in picking the best setup for your business needs.

Ownership Differences: LLCs vs. S Corps

Management Differences: LLCs vs. S Corps

LLCs and S corps manage their businesses in unique ways. LLCs are flexible, letting you choose between member or manager-led setups. In a member-managed LLC, everyone pitches in just like in a partnership. But, in a manager-managed LLC, certain people run things like in a company. The rest are more hands-off.

On the flip side, S corps run on a board of directors and officers. Directors lead big decisions and watch over the company. Officers handle the everyday tasks. Shareholders in S corps are more about owning and less about running the show.

The way LLCs and S corps run things can change how much owners get to decide and do in the business.

LLCs S Corps
Offer member-managed or manager-managed structures Follow a director and officer structure
All members actively participate in decision-making Directors oversee corporate affairs
Managers handle day-to-day affairs Officers manage daily business operations
Members have an active role in the business Shareholders have limited involvement in management

The table clearly shows how LLCs and S corps take on different management styles. LLCs give more room for owners to get involved directly. Meanwhile, S corps use a more layered management form with a clear hierarchy.

Ongoing Formalities: LLCs vs. S Corps

Business owners should know that LLCs and S corps have different rules to follow. These rules help them stay legally up to date. Let’s look at what each type has to do.

LLCs

LLCs have fewer ongoing tasks compared to S corps, which is good news. But they still have important things to do:

  • Registered Agent: Every LLC must have a registered agent in its home state. This person gets legal documents for the LLC.
  • Annual Reports and Fees: LLCs need to file reports and pay fees every year. These reports share the company’s updates, like its location and who’s in charge.
  • Change Notifications: If an LLC changes its name or who its registered agent is, it must tell the state. This keeps the state’s records accurate.
  • Qualifying to Do Business: Wanting to work in another state? Then you have to do some extra paperwork. This is known as “qualifying to do business” in that state.
  • Internal Formalities: Even though not all states require it, having an operating agreement is wise for LLCs. This agreement talks about who owns what and who does what. Some LLCs also sell shares of the company and note big decisions well.

S Corps

If you own an S corp, get ready for more formalities than with an LLC. These steps are part of being a corporation:

  • Registered Agent: S corps need a registered agent too, just like LLCs.
  • Annual Reports and Fees: Just like LLCs, S corps also file yearly reports and pay fees. These reports talk about the company’s status and its people.
  • Change Notifications: Any big changes—like a new name or agent—need to be reported to the state. This keeps the state’s info current.
  • Qualifying to Do Business: S corps might also have to do extra paperwork if they work in another state. This is the business qualification process.
  • Internal Formalities: But there’s more. S corps must have bylaws and follow them closely, sell stock to shareholders, have official meetings, and keep a record of those meetings. These rules are to make sure the corporation runs well and is transparent.

Understanding these differences between LLCs and S corps is crucial for anyone running a business. Knowing the rules helps with legal compliance and the business’s overall health.

Ongoing Formalities LLCs S Corps
Registered Agent Required Required
Annual Reports and Fees Required Required
Change Notifications Required Required
Qualifying to Do Business May be required May be required
Internal Formalities Recommended (Operating Agreement) Required (Bylaws, Stock Issuance, Director/Shareholder Meetings)

LLCs as an S Corp: Tax Considerations

LLCs can choose to be taxed as S corps. This choice gives them tax benefits. They get these advantages while still having the flexibility and protection of being an LLC.

If an LLC is taxed as an S corp, the owners might save on self-employment taxes. This is different from what happens with sole proprietors. Those owners of LLCs must pay self-employment taxes on all their profits.

With an S corp, owners can pay themselves a salary. This salary will be taxed, but the remaining profits given out after the salary are not subject to these taxes.

Yet, LLC owners wanting S corp status must be careful. The IRS looks closely at the salaries of S corp owners. The salary should be fair and not too high. If an owner takes too much in profits without a proper salary, they might face IRS penalties.

It’s wise for LLCs looking at S corp status to work with accountants. Accountants can help with the tax classification and the right salary. They can make sure owners get the most out of the tax benefits without breaking IRS rules.

Choosing S corp status can be a smart move for LLCs. It lets owners save on some taxes. But, making this choice means dealing with IRS rules. It’s important to have professional advice to do this right.

Benefits and Drawbacks: LLCs vs. S Corps

Both LLCs and S corps have upsides and downsides. Here’s a closer look at each type:

Benefits of LLCs

  • Flexibility in Ownership: LLCs allow for unlimited ownership, making it easy to bring in new members or investors.
  • Flexible Management Structures: LLCs provide the option for member-managed or manager-managed structures, allowing for the desired level of involvement.
  • Choice of Taxation: LLCs can choose to be taxed as a pass-through entity or as a corporation, providing flexibility in tax planning.
  • Limited Liability Protection: LLC owners have limited personal liability for the company’s debts and obligations.
  • Less Formalities: LLCs typically have fewer formalities and reporting requirements compared to other business entities.

Drawbacks of LLCs

  • Higher Self-Employment Taxes: LLC owners are subject to higher self-employment taxes compared to S corps.
  • Limited Lifespan: Some states have limitations on the lifespan of an LLC, requiring additional steps to continue the business beyond a certain period.

Benefits of S Corps

  • Pass-Through Taxation: S corps provide the benefit of pass-through taxation, where the profits and losses of the business are passed through to the shareholders’ personal tax returns.
  • Reduced Self-Employment Taxes: S corp owners can potentially reduce self-employment taxes by paying themselves a reasonable salary and taking additional profits as distributions.

Drawbacks of S Corps

  • Shareholder Restrictions: S corps have limitations on the number and type of shareholders, potentially limiting ownership options.
  • More Formalities: S corps have more extensive reporting requirements and formalities compared to LLCs, including holding regular corporate meetings and keeping detailed records.

It’s key to thoroughly look at the benefits and drawbacks of an LLC and S corp for your needs. Think about tax, liability, how you want to run things, and manage. Getting advice from experts like tax attorneys and accountants can help you choose wisely.

Drawbacks of LLCs and S Corps

Deciding between an LLC and S corp requires weighing their pros and cons. By looking at what fits your goals best, you can decide wisely.

How to Choose: LLC vs. S Corp

Choosing between an LLC and an S Corporation depends on what your business needs. You have to think about tax rules, how each protects your assets, and how you want to manage things.

First, look at your business type and how many people own it. Think about what your business does and where you want it to go. This will help you see if an LLC or an S Corp fits better.

Then, consider the good and bad of each type. LLCs are easier to work with and can share business taxes with owners. S Corps let you pay less tax for being self-employed but have more rules to follow.

Getting advice from tax and legal experts is smart. They can clear up tax stuff and make sure you don’t miss any rules.

Evaluating Tax Implications

Understanding the tax impact is key. You need to look at self-employment, income, and social taxes. Both LLCs and S Corps have their tax perks. It’s important to see which one helps your business save more money.

Liability Protection

Safety for your personal money and things is a big deal. Both LLCs and S Corps protect your personal stuff from your business debts. This is important if you’re worried about getting sued or covering debts.

Ownership Structure

How you can own the business matters. LLCs let anyone be an owner, which is good for big groups. But S Corps have a member limit and must have certain types of owners, like U.S. citizens.

Management Preferences

Who runs the show is also a key choice. LLCs give you lots of ways to set up management. S Corps are more like traditional companies, where the board looks over things and officers manage the day-to-day.

The choice between an LLC and an S Corp is big for your business’s future. By looking closely at what you need and your preferences, making a choice that helps your business is possible.

Conclusion

Choosing between an LLC and an S corp is important. You need to look at what your business needs and goals are. Both types give limited liability, but the way they work is different.

LLCs are more flexible with who can own and run them. This makes them good for small businesses. They have less paperwork too. S corps, however, have more rules about who can own them and need to report more.

It’s key to think about taxes, protection from lawsuits, and how you want to run your company. Getting advice from tax experts and accountants is a good idea. They can help you understand which choice is better for your business.

Discussing your business’s needs with professionals helps a lot. With their help, you can make a choice that will help your business grow.

FAQ

What are the differences between an LLC and an S corporation?

LLCs and S corporations are different in how they are owned and run. They also have different rules to follow.

What are the similarities and differences between LLCs and S corps?

LLCs and S corps protect owners’ personal assets. They both have their own legal standing. But, they differ in who can own them and how they are managed.

What are the ownership differences between LLCs and S corps?

LLCs let anyone own part of the business. But, S corps have rules on who can own shares. For example, they limit it to people, not other businesses or trusts.

What are the management differences between LLCs and S corps?

LLCs let the owners run things or hire managers. S corps are more like traditional companies with directors and officers.

What are the ongoing formalities for LLCs and S corps?

Both have to follow their state’s rules to stay in business. But, S corps have to do more, like holding regular meetings and keeping records of the meetings.

Can an LLC be taxed as an S corporation?

Yes, an LLC can choose to be taxed like an S corp. This can be good for saving on certain taxes. It also lets owners take some money as salary and some as profit, which can be an advantage.

What are the benefits and drawbacks of LLCs and S corps?

LLCs offer a lot of flexibility and may have lower taxes. However, you might pay more in self-employment taxes. S corps offer tax benefits but need to follow more rules and have some ownership limitations.

How do I choose between an LLC and an S corp?

Deciding between an LLC and an S corp means looking at what your business needs. Think about taxes, how the business will be run, and who can be an owner.

What factors should I consider when choosing between an LLC and an S corp?

Think about the business’s size, who the owners are, and what the business does. Consider what goals you have for the future. Also, look at the pros and cons of each type of business structure.