LLC vs. S corp: A side-by-side comparison
Out of all the strategic decisions new business owners have to make, business structure is one of the most important. How you organize your company will affect nearly every aspect of operations — as well as your personal liability. And in many cases, only registered businesses can get access to the best bank accounts and startup funding.
Of course, each type of business entity has its own set of perks, rules, and restrictions. In the LLC vs. S corp debate, the main differentiator is tax status. Limited liability companies (LLCs) and S corporations offer unique tax advantages for small business owners. But your ability to tap into those benefits depends on your state, number of shareholders, and other factors.
Get the facts on LLCs and S corps so you can make the right decision.
LLC vs. S corp overview
The legal structure of your business will determine your tax status, personal liability protections, accounting method, reporting requirements, and more. It also controls how you can share company profits and deduct business expenses.
In the U.S., there are five small business structures available to most entrepreneurs:
- Sole proprietorship: The default business structure if you aren’t registered
- Partnership: Allows for multiple owners with different levels of liability
- Limited liability company: Offers personal asset protection and the flexibility of sole proprietorships
- C corporation: Taxes business profits at both the corporate and personal level, known as double taxation, while limiting liability
- S corporation: Offers the benefits of incorporation without double taxation or complex accounting rules
What you need to know about LLCs and S corps is that they are both pass-through entities. With pass-through entities, owners report their business income on their personal tax return.
Under both structures, you pay taxes at the individual rate rather than the typically higher corporate tax rate. It’s a welcome benefit for cash-strapped founders, but this is where the similarities largely end. See what sets LLCs and S corps apart.
What is an LLC?
A limited liability company essentially creates a legal division between its owners, known as “members,” and the business. You can start as a single-member LLC or register with multiple LLC owners.
LLCs offer the best of both worlds when it comes to business taxation and risk. With this structure, you’re able to select your tax status based on how it benefits you. You can elect to be taxed like a sole proprietorship, partnership, or corporation.
For example, say you choose sole proprietor tax status. The IRS would treat your business as a “disregarded entity.” That means your business profits and losses are reflected on your personal income tax return, so you don’t pay any corporate income taxes.
Sole proprietors are held personally liable for their company’s debts and liabilities. But as an LLC member, you’re legally separate from your business. So, you get your preferred tax rate plus liability protection.
Keep in mind that some business types, like financial institutions and insurance companies, can’t form LLCs. Regulations also vary state by state. Check with your state registration agency to see if you’re LLC-eligible.
Advantages of LLCs
Now that you know what an LLC is, discover the qualities that give this business entity the edge.
- Limited personal liability: This business structure specifically shields entrepreneurs from personal financial risk when operating a business. LLCs — not LLC members — are responsible for their debts. Your personal assets can’t be seized to pay down business debt obligations.
- Ongoing tax benefits: When you form an LLC, you’re allowed to adopt the tax status of other business structures. If you select sole proprietor or partnership status, the LLC’s income and expenses will “pass through” to your individual tax return. You’ll pay taxes based on your personal income bracket and avoid double taxation. This refers to when entrepreneurs have to pay individual and corporate taxes.
- Greater business control: Corporations can be more challenging to manage. They’re required to maintain a board of directors, adopt bylaws, generate regular reports, use the cash accounting method, and more. In most states, LLCs don’t have these recordkeeping and operational requirements.
- Profit distribution: With LLCs, members have much more flexibility and control over how they share profits. Corporations have to distribute gains to shareholders based on the number and kinds of stock they own. As an LLC member, you can divvy up profits however you wish — so long as your partners and investors agree.
Forming an LLC
Requirements for registering an LLC vary by state, but there are some similarities you can count on. First, you’ll need to choose a business name and, potentially, a doing business as (DBA) name.
To register, you need to create and file articles of organization and pay any state and local fees. In addition to basic business information, you’ll list out the powers, rights, and duties of each LLC member. You may also have to register for an Employer Identification Number (EIN). According to the IRS, most single-member LLCs that have elected to be taxed as individuals need an EIN.
Websites like LegalZoom can help you complete the necessary paperwork, submit your business name, and get registered.
What is an S corp?
An S corporation is any corporation that’s treated as a pass-through entity for federal tax purposes. (The “S” refers to an IRS code section, Subchapter S of Chapter 1 of the Internal Revenue Code.) Technically, an S corporation is a tax designation, not a formal business entity. If a business has S corp status, profits and losses are passed through to the owners. That includes corporate income, losses, deductions, and credit.
S corp owners, known as shareholders, receive the same protections as C corporation owners. But unlike a C corp shareholder, you avoid double taxation at the individual and corporate tax level. You’re only subject to your individual tax rate. In addition, S corps offer limited liability protection. That makes it a natural progression for sole proprietors and general partnerships.
A commonly cited disadvantage of S corps is the ownership restriction. There can be no more than 100 owners, and they must be individuals (or the living trusts of individuals). This is in contrast to LLCs, in which individuals, corporations, foreign entities — and even other LLCs — can own a stake in the company. There’s no limit on the number of LLC members.
Advantages of S corps
If you're still debating over an LLC or S corp, see what makes this legal entity an attractive choice:
- Protected personal assets: “Limited liability” may not be in the title, but S corporations also guarantee liability protections. As an S corp owner, your personal assets aren’t in jeopardy if your business cannot make its debt or liability payments.
- No double taxation: In most cases, S corporations are exempt from federal income taxes, so owners are taxed only once. This offers valuable savings for new and growing businesses. It’s important to note that not all S corps qualify for this pass-through tax treatment.
- Lower self-employment tax: Organizing your business as an S corporation can decrease your taxable income. You’re able to split your business income into salary and distribution, only paying self-employment tax on the salary portion. You can also minimize your Social Security taxes and Medicare taxes by controlling your salary.
- Independent lifespan and ownership: Unlike other structures, S corporations have an independent lifespan. This means that the business doesn’t end when shareholders depart. It’s also easier to sell S corps, transfer interests, and ensure the continuance of the business.
Forming an S corp
To receive S corporation status from the IRS, you have to submit a completed copy of Form 2553, signed by all shareholders. You’ll file articles of incorporation with the appropriate state agency. Any application and processing fees at the federal, state, and local level must also be paid.
Not all companies with S corp status need an EIN, but it doesn’t hurt to apply for one. Many banks require an EIN to open a business bank account (unless you’re a sole proprietor).
The big picture
Your choice of business structure will have an enduring impact on your organization. Now that you’ve read this LLC vs. S corp comparison, you should have a clearer idea of which entity suits your needs.
If neither option is viable for your company, don’t worry. You can find the right fit with our handy guide to the 6 kinds of corporations.