Limited liability companies (LLCs) and S (Subchapter) corporations are often discussed together, but this is misleading. 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.
Whether you're curious about establishing an LLC or about launching an S corporation, starting a business is an exciting undertaking full of learning experiences. You can use this guide to sort out the differences between LLCs and S corporations to make the best decision for your business.
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.
LLCs offer a formal business structure, while they can also be taxed similarly to sole proprietorships 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.
What Is an S Corp.?
An S corporation is a tax classification that can protect small-business owners' assets from double taxation. 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. 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 we 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. We'll dig into these differences below.
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.
- S Corp. Owner can be hands-off or take a salary as a company employee
- LLC. Owner can be hands-off or participate in organization management
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. 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.
- S Corp. 100 or fewer owners; must be U.S. citizens or U.S.-based trusts
- LLC. Unlimited owners with no restrictions on classification or nationality
A corporation has a board of directors who make high-level 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.
- S Corp.: Shareholders choose a board of directors; officers run daily operations
- LLC: Managers run daily operations and can appoint officers if desired
Stock and Shareholders
An S corp. can only issue common stock, which gives voting rights to shareholders. An LLC cannot 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, you can't issue stock.
- S Corp. Common stock with shareholder voting rights
- LLC. No stock or shareholders at all
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.
Common Considerations and FAQs
Check out these frequently asked questions to choose the right structure for your situation.
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.